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Is what happens on “Billions” myth or reality?

Are hedge fund investments inherently risky?


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If you’ve seen the Showtime series Billions, you may have wondered how closely the show mirrors the real world of Wall Street power brokers.

Billions follows the conflict between two brilliant and ruthless men: hedge fund manager Bobby “Axe” Axelrod (Damian Lewis) and U.S. Attorney Chuck Rhodes (Paul Giamatti). Their battle is fierce and made even more complicated by the fact that Chuck’s wife is a long-time employee of Axe’s firm, causing an inherent conflict of interest for both men.

Yet despite that far-fetched scenario, Billions succeeds in accurately portraying the risk involved in investing as a hedge fund manager and the immense wealth that can be made by betting against the market.

There are essentially two ways to participate in the market: You can go “ long the market “ and buy stocks, or “ short “ stocks and sell borrowed shares you don’t own that you will buy back at a later date.

Axe obtains his fortune in the most callous way ever: by shorting airline stocks after the first plane crashed into the World Trade Center on 9-11. (Even worse, Axe's then-colleagues died in the attacks; he wasn't in their World Trade Center office because he was being fired for shady dealings and was at an attorney's office to discuss his severance package.)

The stock market was still open after the first attack happened because no one knew exactly what to think. Most traders assumed it was some sort of bad airplane accident and not part of an awful terrorist plot. It wasn’t until the second tower was hit that Wall Street figured out what kind of impact these attacks would have on our country, economy and specifically, airline and transportation stocks.

Axe knew right away that the best way to make a massive profit was by selling airline shares short. Meaning he would sell the airline stocks that he didn’t own at the going market price, hoping that these stock prices would fall dramatically, and then Axe would later buy back these same shares at a much lower price and an enormous profit.

For example, let’s say XYZ airline was trading at $100 a share when the first plane hit i the World Trade Center, Axe tells his broker to borrow a 1000 shares that he doesn’t actually own at that price or better. The broker confirms this trade at $100 a share. The second plane hits and the stock instantly drops to $50 a share. Axe then tells his broker to buy back the shares he didn’t own at $50.

The difference between the price he sold XYZ airline stock short ($100) and the price Axe bought back this same stock ($50) or the $50 difference a share is the profit Axe made on this trade. Axe would have made $50,000 in a matter of minutes. However, in this instance Axe sold thousands of airline shares short and made millions in the process.

Shorting stocks is the single most-risky way to invest, simply because you don’t know what your downside risk is going to be. If you are long in a stock, it can only go to zero and you lose all of your original investment, but at least you know what that amount will be. If you sell a stock short and the stock continues to go up, there is no way to quantify your loss until you finally cover your short position.

Hedge fund managers have to be both long and short the market at the same time, thus the use of the word hedged, on both sides of the trade. What separates these hedge funds is what securities they are trading and what percentage they are long the market and what percentage they are short the market. A typical hedge fund might be 70 percent long and 30 percent short. A traditional mutual fund, in contrast, is 100 percent long.

Hedge funds are actually good for other investors because they provide a lot of liquidity. At any given time, a hedge fund manager may have to buy back stocks they don’t own to cover their shorts. This helps the market because it provides another buyer of securities for someone else who may need to sell for whatever reason.

There have been studies done today that show, because of the proliferation in high frequency traders and hedge funds, the average holding period for a stock on the New York Stock Exchange is only 27 seconds.

Interestingly, since 2008 and the financial crisis, hedge funds have not performed as well as “long-only” managers because stocks have risen. The market in general is up over 200 percent since the bottom on March 9, 2009.

The one thing that hasn’t changed however, is the obscene amount of money hedge fund managers continue to make. According to Institutional Investor’s Alpha magazine “ the top 25 hedge fund managers made an average of $517 million in 2015, and had combined earnings of $ 12.94 billion “.

Maybe the show isn’t so off the mark after all?

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Fred Taylor

Fred Taylor is president and co-founder of Northstar Investment Advisors, LLC. The firm specializes in managing personalized investment portfolios for individuals, families, and retirees with a focus on income generation. He is a member of the Colorado Forum and also served as an economic advisor to Colorado Governor Bill Ritter from 2008 to 2010.

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