Operating other people's funds
The source of funds for trading may affect the style and performance of the operation, which is probably hard for most people to understand. As Bill Lipschutz explained, even the most experienced traders would find it hard to understand, unless they experience it personally.To know what is Bill Lipschutz's trading framework?
"Initially, I didn't understand that there was a difference. Seven years ago, I naively thought that whether the capital came from the Solomon Brothers, ten wealthy individuals, or a single client, the result would be the same. My goal was to squeeze the maximum profit from the market."
"Different sources of funds will inevitably lead to different trading strategies, forcing the trader to change the motivation. The problem is not simply to say: 'I have some funds on hand, regardless of the source, I will do my best, and try to earn some profits every day.' It's not that simple. A company facing wealthy clients will naturally generate many different forces, and the monthly performance will determine your life and death."
"Fund management is a very tricky industry. The problem is not only the operational performance but also the customer's expectations for the investment results. Absolute performance data often cause misleading."
"I can tell you: 'In the past five years, the total return of our most aggressive product is 600%', you might say: 'Wow! 600%' But if you don't know the operational performance of other foreign exchange managers, or the risk we take to achieve this performance, the data itself has no clear meaning."
"For example, suppose a manager manages 200 million US dollars of funds, of which 120 million US dollars belong to a specific investment target fund. If this part of the fund earns a 600% return in four years, investors are likely to withdraw capital, because the risk structure of the fund does not meet the expectations of investors. Fund management is a very complex game, often contrary to common sense judgment."
"Let's consider the different trading methods between George Soros and Peter Lynch. Soros usually operates through a high degree of credit expansion, and the only goal is to make big money."
"Peter Lynch's Magellan Fund is quite different, the primary goal is to protect capital. He is in a big bull market, and he is also a top stock picker, so he made a lot of money. But believe me, as soon as the performance of the Magellan Fund begins to decline, you will see investors withdraw capital in large numbers, and the fund will disappear in the end."
"People who give money to George Soros are mentally prepared, the fund value may suddenly drop by 20-30%. I don't think anyone will diversify their investments. Investors' motivations are very different, and investors will choose funds that suit their style. In the end, the preferences of customers will inevitably affect the trading style of the trader."
"As Bill Lipschutz explained, different sources of funds mean different customer motivations and fund operation purposes, which may also affect your trading style. As traders, we all need more capital."
"If the operation goes well, we will sooner or later need new sources of funds, either borrowing (without accepting norms) or raising customer funds. No matter what the source of funds is, you have to understand one thing, because your trading style may be affected, and it will also affect the trading performance."
"The worst case is that the performance declines and the funds are not your own. Therefore, before pursuing new funds, you must carefully evaluate how your trading will be affected."
The sources of trading capital are different, and the simplest one is own funds. Bill Lipschutz explains how he operates his funds and what are the advantages of individual traders according to Bill Lipschutz?
"For pure speculative funds other than investment, I have a high tolerance for risk. In principle, if I lose all the speculative funds, I can accept it calmly."
"Of course, I don't think I will suffer a complete loss, but I am mentally prepared for this. Now I have some investments, including my own house, which is an investment, and I also have a stock portfolio, which is also an investment."
"The remaining funds can be used for speculation, and I expect a higher rate of return than investment, but I am also prepared to accept higher risks and serious price fluctuations. This kind of trading has a high destructive risk, in other words, it may cause 100% loss."
For his funds, Bill Lipschutz only needs to be responsible for himself, and he can trade completely according to his preferences. However, for other people's funds, the freedom is reduced, and he explains this point next.
Other people's funds
"But when you are entrusted to manage the funds of customers, it is another matter. Customers say, 'I know you are a speculative trader, and I can accept a 20% loss.' I often talk to customers in detail and try to understand their thoughts."
"I hope customers fully understand what we can and cannot do. If a customer looks me in the eye and says, 'I can accept a 20% loss, no problem.' In this case, we know he means 5%. If I call him three days later, 'Do you know? Your net worth has fallen by 18%, and I want to know your thoughts so that we can discuss the next steps.' I guarantee that he must have forgotten his previous statement about a 20% loss."
"Because customers are not traders, they may not be able to handle serious losses properly. When you accept the commission to manage the funds of customers, you have a responsibility to assist them and not let them fall into an emotionally unprepared situation. You can't take the customer's funds and simply go crazy in the market."
"For a fund manager, if you buy IBM stock and the price drops by 25%, no one will fire you because everyone owns IBM. This is a prudent investment. But if you buy a network speculative stock, the price rises by 80% and then falls, and then the company goes bankrupt, you might have to pack up and leave. Customers will withdraw funds, and you may never be able to raise funds again."
"The problem is not just the rate of return, but the customer's investment decisions involve many different motivations. This will directly affect the level of trading."
"If a trade has a high chance of winning, why not invest more money? Well, because of a wrong judgment, even if the probability is only 5%, the result is far worse than a correct judgment, even if the probability of a correct judgment is as high as 95%. Some traders think, 'Hey! If I help customers earn 25%, they will be very happy and think I am a great trader, then I can earn a lot of management fees.'"
"But do you know? If there is a 5% loss, they will withdraw funds, and I may have to close down." So, trading decisions are not just about the odds of winning or losing, the situation is much more complicated. Generally speaking, in addition to the odds of profit and loss, traders also have to consider a lot of related issues.
"So, operating customer funds is much more complicated than own funds. You have to consider the possible outcomes of the trade and the possible reactions of the customers. Your decision will inevitably be constrained by the customer's response, and then affect the performance of the operation. For the company's funds, the pressure is relatively small, and the space for play is also larger. Bill explains this point next."
"Managing the funds of individual customers, and protecting capital is the key goal. As a company trader, the goal is to make money. In addition, the company is more able to accept losses. For a company, the focus is on whether the company wants to intervene in foreign exchange trading, and the performance of individual traders will not affect this conclusion."
"For example, if a company loses 20 million US dollars, it may fire the trader who operates, but it is unlikely to withdraw from foreign exchange trading. Therefore, the foreign exchange market itself will rarely be the object of blame."
"Since operating other people's funds must be subject to various restrictions, this may raise a question: "Why not borrow from the bank with collateral, and repay the loan regardless of the performance of the operation?" Unfortunately, due to various practical difficulties, this feasibility often has to be ruled out.
"First of all, if an investment bank or company is ready to entrust the trading or speculative product to an individual to manage, they usually want this person to enter the company system. This is not to exclude giving funds to others to manage, but it involves many sensitive issues. Whoever supervises this operation or approves the loan may break the rice bowl because of it."
"For example, suppose you give the funds to someone else to manage, and if there is a loss of millions, everyone will ask: 'Who approved it?' Then, you will be fired. On the other hand, if the company gives the funds to a department to manage, this is the company's decision. If there is a loss, these decision-makers will not lose their jobs because of it."
"In short, you have to consider various sources of funds available for use, evaluate the possible gains and losses they may cause, and then make the final decision. Is it worth it if the hen that lays golden eggs reduces production because of external funds? In other words, what is the point of getting extra funds if you can't improve your trading performance?
"Therefore, before accepting new funds, you have to consider the following questions:
- What are the expectations of the fund provider?
- What are his real expectations?
- Does my past performance match the expectations of the fund provider?
- Can my performance meet the real expectations of the fund provider?
- What are the consequences if I can't meet the expectations of the fund provider?
- How much control does the fund provider require?
- How often does the fund provider evaluate the performance of the operation?
- What is the personality of the fund provider? Is he difficult to deal with and constantly causing trouble?
- Can some norms be set?"