10 Finance Terms Every Fund Manager Should Know

Welcome back to the channel. Today we're going to talk about 10 confusing finance terms that everyone should know. Now I'm the founder of 3 investment funds, another company called Fund Launch, done over 8 figures in 2 and a half years. And on this channel, we primarily help people start, launch, and scale investment funds. But today we wanted to pull things back and go through a top 10 list of confusing financial terms. And even if you're a middle advanced person, 8 or 9 actually might help you as well. So let's kick it off with number 1. What is a mutual fund? A mutual fund is a pool of investments. So just a A pool of capital that a group of people usually actively manage, meaning there are real people that buy stocks, bonds, other investments in a group. The usual goal of a mutual fund is have diversified risk across a huge portfolio. But the downside is they typically take a good chunk of fees. And after fees, most mutual funds actually don't outperform just the standard market. Meaning if you just bought the S&P 500 or the Dow Jones, these big market ETFs, which we're going to talk about in a second— what is an ETF? Mutual funds typically don't outperform. So before investing, be careful, look at fees and just make sure to get into good mutual funds. Which leads us to number 2, ETF or an exchange-traded fund. Now, ETFs are similar to mutual funds, but typically are not managed as heavily by direct people. A lot of times they're managed by computers in the background. But like mutual funds, they're usually collections of hundreds or even thousands of stocks put together in one little bundle. Because they're managed by computers, they typically have a lower operating expense and charge very low fees. There are equity ETFs. There are country-specific ETFs. There's emerging market ETFs. So if you say, hey, I would love to invest in third-world countries, there are ETFs for that. Or if you said, I want to invest in healthcare, there's ETFs that go and buy up hundreds or thousands of healthcare stocks into one ETF. They're actually a really cool solution. And even Warren Buffett said if he dies, he wants all of his money going into broad market ETFs. Number 3 is carried interest. Now, carried interest is specific to investment funds like what we talk about on this channel. Earlier, we talked about mutual funds, which anybody can buy. Typically, private investment funds are private. They're only offered to high net worth individuals. Usually a barrier of entry is $100,000 to a few million dollars to get into a private investment fund. Now, the term carried interest means in non-technical terms, just a profit share on the portfolio. Most large investment funds that are private charge 20% of the profit goes to the managers or 20% of the carried interest. So meaning if we had a $100 million fund and this year we made $40 million, a 40% return, we would split that with our investors 80/20. So 80% of that $40 million would go to the investors and 20% would come to us as the fund manager. So $8 million would come to us as the managers. This is why investment fund managers are one of the wealthiest people on planet Earth. According to a 2021 survey performed by Hedrick and Struggles, carried interest accounted for 84% of compensation that goes to fund managers that are making billions and billions of dollars. Definitely a term that you should know. Number 4, rebalancing. Most investments you see, they typically put it into a pie chart. Have you ever seen that where 25% goes to X and 30% goes to Y and they have this whole nice pie chart put out? Oftentimes while you start a portfolio, those percentages are going to change because some areas are going to perform very well. And some parts of that pie chart might do really poorly and shrink. The process of rebalancing a portfolio is when you take that portfolio that started out as a nice circle and now has been skewed into all these different percentages. What you do is you sell some of your winners and you buy back some of your losers and you rebalance your portfolio back to the percentages that you decided on at the beginning. Most investment managers say you should do this on a quarterly or semiannual basis for the best long-term results. And by the nature of doing this, you actually get to sell when things are high and you buy buy back in on other areas when things are low back to your portfolio mix on that pie chart. Number 5, fund of funds. A fund of funds is kind of in the name. A fund of funds is a fund, so pooled investment, so pooled capital that goes and invests into other funds that are pooling other capital. This is also known as multi-manager investments, and this replaces their direct investment to a stock or a bond. Now they do this for a few reasons. Number 1, they can often get discounts on those other investments. So your fund of funds has a And you go write a check of $100 million to another fund, they oftentimes will give you discounts on their fees. Number 2, many funds are exclusive and you can't even get in their funds. For example, Ray Dalio's Bridgewater Funds, their minimum investment is $100 million. So if you're a regular person like me and you, we can't even get into their funds, but we could invest into a fund of fund that has enough capital together to then write a $100 million check to get into these bigger funds. And then finally, they offer diversification. So instead of just taking your money and putting it on one little pony, you can put it into a fund of funds that's going to invest into a bunch of other funds that are then investing into other assets. It's just a lot of diversification all put into one. Number 6, liquidity. Liquidity is the effective ease in which a security, a stock or bond or whatever, can be converted to cash and how quickly and effective it can be done. Different ratios such as current, quick, and cash ratios are uses of measurement to decide how much liquidity you have. One of the biggest problems in the 2007-2008 crash was there was a lack of liquidity in the markets, meaning people had investments and they couldn't convert to cash fast enough. And what it meant was they had to hold those investments as they dropped even lower and lower as other people were trying to liquidate into cash. On the other side of the coin, COVID happened and the central bank said, we're going to make sure we have plenty of liquidity. We're going to flush the markets with stimulus and other stimulus and more stimulus and stimulus on stimulus. Okay. They wanted to make sure we had liquidity. And guess what? It worked. We had tons of liquidity, almost too much liquidity, where inflation is now over, you know, 8.5%, 9% right now. That's how much liquidity they provided to the markets. But having liquidity typically is a good measure, especially when you have a broad portfolio. You want to know how quickly you can convert to cash in case you need to pay off old debts or do other things with your money. Number 7 is high watermark. This is the highest peak value that a fund has obtained over its period and life cycle. Now, why is this It's so that you don't get double feed in your fund. So for example, if you put $100 into an investment and we're doing an 80/20 split, meaning the investor takes 80%, the fund manager takes 20%. You put $100 right today and that investment does very well. It goes up to $150. That first little slide, the fund manager would take their 20% split, which is awesome. But let's say now the fund drops like crazy and goes negative. You started $100, it went to $150, and now we're at $80. Shoot. Well, the fund manager is going to take no performance fee because they didn't do a very good job. But let's say now the fund goes back from $80 back to $150. If you didn't have a high watermark, the fund manager would then take another 20% on that gain from $80 to $150, meaning you got feed at the beginning, you got 20% taken at the beginning, and then another 20% taken later for the same performance. But once they reach that high watermark, anything above that from 150 to 160, they would make an 80/20 split. Number 8 is arbitrage. The most basic definition is buying something in one market and selling it for a different price in a different market. An example of arbitrage would be if you're at the water bottle factory, a water bottle may be only worth a dollar apiece. But if you're in the middle of the Sahara Desert and there's no water around, you could sell that water bottle for $10 or $15 or $30. The product is the same. But the market is different. You're selling the same product you have in one market for a different price, the Sahara Desert, in a different market. This can become pretty interesting in the world of finance. Sam Bankman-Fried is probably the best example of this of all time. The dude just turned 30 years old and he's worth $28 billion. He's the founder of FTX and got his entire start trading Bitcoin from one market to another. There was a huge demand for Bitcoins in Korea. He could buy Bitcoins at $7,000 or $8,000 and sell them in Korea for $15,000 or $16,000 almost instantaneously. He made hundreds of millions of dollars in college doing this. It was a simple arbitrage play and made him a home run success. Number 9, asset allocation. This is an investment strategy for whatever client to meet their goals or investment strategies and to allocate or deploy capital into certain portfolios or other places to help them reach those goals. This is the process of dividing their investments across asset classes class and other things again to reach their goals. Asset allocation is individual for each individual. For a big firm, it could be specific to that firm, but it's the process of allocating assets or allocating capital to meet your goals. Number 10 is due diligence. The process of due diligence is doing research on a certain investment category or company, and in most simple terms, it's just doing your homework. Due diligence, or DD, is the process of just digging into whatever you're going to invest into or partner with or merge with And making sure you understand everything completely to give an estimate or a price on that asset. So, for example, when you buy a new car, you go do due diligence. You test drive it. You look at the brakes, the tires. You make sure it's the right fit. You make sure it looks good. The paint looks good. Some people do way more due diligence. Some people do little due diligence. The same thing's true with investment products. Y'all are amazing. Comment below other terms you'd like to go over in this channel. You guys are amazing. Like, subscribe, check out the other videos below. We'll see you guys next video. Bye. Bye.