How do hedge fund people make billions

Hedge funds : How does David Tepper make $ 3.5 billion in a year?

Hedge fund manager David Tepper made $ 3.5 billion in one year, more than a hundred times as much as Wall Street bankers. How he did it is no secret. The question is what investors can and can't learn from it.

The anecdote of David Tepper and the pancake

There is usually an anecdote about people who have become extremely rich that they like to tell about themselves. It's no different with David Tepper and, as is usually the case, it's about failure. He was a bad student. A pancake stand in front of the school was to blame. Again and again he skipped school to eat enough.

While the names of the great bank bosses are on everyone's lips - Josef Ackermann or his successors Jain and Fitschen, Lloyd C. Blankfein from Goldman Sachs or Jamie Dimon from JP Morgan - David Tepper was hardly known to the public. That has now changed suddenly. Tepper made a whopping $ 3.5 billion in the past year, more than anyone else. By comparison, JP Morgan's Jamie Dimon, a top earner among bank chiefs, only made $ 20 million. That's not even one percent of what Tepper earned.

Some people very quickly converted how much Tepper earned per day. Daily rates of almost ten million were then determined, and if you only count the working days, even more.

Thomas Piketty and the increasing inequality debate

The sudden general awareness of David Tepper could not be explained without the new debate about social inequality in the USA and - afterwards - in Europe. It was initiated by the French economist Thomas Piketty from the Paris School of Economics, who was celebrated like a rock star of the economy at the launch of his book "Capital in the 21st Century" in the USA. The Obama administration was also interested in the findings of this economist, who has shown that capitalism inevitably leads to ever greater inequality and wealth concentration, which can only be overcome with a wealth tax. For Americans and Germans, the latest figures are also frightening, which show that the incomes of the middle class in these two countries cannot keep up with economic growth. The report about the annual earnings of David Tepper, about which the trade magazine "institutional investor’s alpha" has now reported, is an additional indication that the economic system creates an inequality that is beyond imagination.

What a hedge fund is and what strategies they use

The question arises as to how David Tepper, who comes from a humble background, worked his way up after a successful degree in economics at Goldman Sachs, made so much money with his two hedge funds in the past year. There is a great deal of information about this which is no secret and which the business press has repeatedly reported.

Tepper has two hedge funds "Appaloosa I" and "Palomina". Hedge funds are investment funds that are hardly subject to any regulation and are in principle allowed to speculate with what and how they want. Hedge funds differ according to the strategies they employ. There are those who bet on both rising and falling markets, there are funds that focus on global fundamental trends and there are those who use various mathematical and statistical trading systems. There are no limits to the development of concepts.

David Tepper bet on particularly bad stocks

David Tepper took an approach called “distressed securities”. In economically difficult times, investors rely on particularly poorly performing companies to pick up again. Tepper mainly relied on stocks in battered companies such as the US airlines Delta or United Continental. Tepper consistently relied on the US economy recovering from the financial crisis. During the financial crisis, he had relied on bank shares with the intention that they would be saved by the state. Small investors who want to copy this are warned. Tepper has since sold the airline's shares again. Crucial to his approach is that he will buy what are known as cyclical stocks at certain times when the economy is down. In the aftermath, fabulous profits are possible when stocks recover from their lows.

Can David Tepper repeat a 42 percent annual return?

Investors who use such success stories as an opportunity to put their money in hedge funds should be careful. The first quarter of this year was the worst for the hedge fund industry since the beginning of the financial crisis, as reported by the Financial Times. In addition, the hedge fund industry has lagged behind in recent years, which has resulted in a significant loss of confidence among investors who have been withdrawing large amounts of money from these funds for months. Whether or not a hedge fund is successful depends not least on whether its strategy fits the current market phase. Trend-following momentum funds, for example, have had quite a problem since the beginning of the year because there is neither an upward nor a downward trend and the markets are instead trending sideways. It almost inevitably happens that funds that have been successful for several years suddenly collapse when the market phase changes fundamentally while others bounce back.

The question is, therefore, whether David Tepper can repeat the 42 percent return on his two funds over the next few years.

Apart from different market phases, the skill of the fund manager also plays a role in actually implementing his strategy. He has proven in the past that David Tepper has this skill and discipline. But last but not least, chance and luck certainly play a major role. The fact that successful hedge fund managers keep experiencing downturns is just too conspicuous.

David Tepper sets the rules for his income himself

But how is David Tepper's income composed? Every year he receives two percent of the total money that his funds collect - part of this money he pays out to his employees - as well as a profit share of 20 percent. As head of the fund, he determines that himself. As long as he has many investors to trust him with the money, he can do that. So if he has a good year, he makes a lot. If the fund makes a large loss - say 40 percent - in another year, it has no profit sharing, but does not lose anything. What remains for him is the two percent of the total fund assets, which is squeezed off for him every year. That means: if the fund wins, it wins. If the fund suffers a loss, that loss will only be suffered by those investors who entrust their money to its fund. His win from last year is safe.

In this respect, David Tepper can sleep peacefully. His once earned money is safe. The 56-year-old is married and has three children. His fortune is now estimated at $ 7 billion. There are people who have more. But they are also much older. It doesn't look like David Tepper is resting on his money. Maybe it's about something completely different. He is the best when it comes to developing a concept and putting it into practice in a disciplined manner.

What can investors learn from David Tepper?

The strength of David Tepper is undoubtedly that he has developed a successful trading system and implemented it in a disciplined manner. The normal investor can also undertake to use a trading system, it can be a very simple one. It doesn't have to be the one that David Tepper uses, especially since it is mentally very difficult to buy stocks when the economy is down and there is only bad news. A trading system can also consist in the investor systematically saving a certain amount every month and buying shares every time 2000 or 3000 euros are together. Because it would be too complicated and risky to select individual stocks, the investor could consider buying an index fund (ETF) in which all stocks of an index are proportionally available. The ETF can track the Dax, the Mdax with medium values, the broad US index S&P 500 or any other index. Index funds have the advantage that they passively track the development of the index and there is no risk of fund managers failing.

The point is to develop a simple system and to stick to it in a disciplined manner

It is already a trading system for an investor to invest disciplined and regularly in the stock market and automatically buy more expensive and sometimes cheaper. Over the next 20 or 30 years, the likelihood of a good return is high. The investor could also do half and half and, when saving, only ever invest half in shares and put the other half in the overnight money account. There are no limits to the possibilities for trading systems. It is crucial that there is a trading system and that it is maintained in a disciplined manner. This is at the core of what successful hedge fund managers heed. In their considerations, retail investors should pay attention to the intermittent losses they could mentally endure. Anyone who panics when a share value of EUR 20,000 has meanwhile become 10,000 - that will certainly happen at some point - should perhaps aim for a smaller equity position. Those who can withstand more can buy more shares. It is crucial that the concept fits your own personality and willingness to take risks.

Literature on the subject:

Brent Penfold, The Worldwide Laws of Successful Trading, Financial Book Publisher, € 34.99

Richard L. Weissman, Mechanische Tradingsysteme, Finanzbuchverlag, € 39.90

Van K. Tharp, Clever trading with System 2.0, Finanzbuchverlag, € 44.90

Now new: We give you 4 weeks of Tagesspiegel Plus! To home page