Sept. 12, 2020

What is a Hedge Fund and can startups raise from them? By Ryan Zhang and Mi Tu.

What is a Hedge Fund and can startups raise from them? By Ryan Zhang and Mi Tu.

Ryan Zhang and Mi Tu, Partners & Co-Founders at Standard Capital L.P. explain how do hedge funds work and how can startup founders raise money from them. We also talked about investing in securities vs investing in startups.

Book recommendations from Ryan and Mi:

The Intelligent Investor - Ben Graham (this is classic, I highly recommend it as well) https://www.amazon.com/Intelligent-Investor-Definitive-Investing-Essentials/dp/0060555661/ref=sr_1_1?crid=291794I5VXHKV&dchild=1&keywords=intelligent+investor&qid=1599935645&sprefix=intellegent%2Caps%2C174&sr=8-1

One Up on Wall Street - Peter Lynch: https://www.amazon.com/One-Up-Wall-Street-Already/dp/0743200403/ref=sr_1_1?crid=2HZI5N30G8ICO&dchild=1&keywords=one+up+on+wall+street&qid=1599935606&sprefix=one+up+%2Caps%2C155&sr=8-1


Transcript

And today as a guest speakers, we have actually two Co, founders and partners at standard capital ryan's a, and me too. And in this episode, we'll talk about hedge funds. What is it? How's it different from a venture capital? 

Who should I should consider raising money from a hedge fund and who should look into that? So, Ryan and meet let's figure it out by you giving us some background on yourselves and on standard capital P. 

Thanks for having us on. My name is Ryan, and I came from China. Seventeen came for high school to America,
and I started college at Penn State,
and then after graduation, 

and worked at JP Morgan Chase became associate,
and then moved to New York for a proprietary trading position. 

And then that's where I met my partner, and we started standard capital earlier this year with a mindset of long term investing. And that's how is born. 

Where that sparked my passion securities and then I met Ryan and my first job after college as a security t's principal at two through trading, 

where we decided to start standard capital together and basically started capital is a hedge fund that only focuses on the long term investment of equities, 

and currently we're still talking to investors either from China or the States because of a covet where we're gonna go back to China, 

you know,
to personally me some of the investors and pitch to them are ideas. 

But because because of Kobe, we really couldn't make it back. So that's where we are at. But we're planning to launch, like, full launch our fund next year in March. 

That's awesome. And best of luck to you and launching a hedge fund. I personally know this Pre big struggle to extra construct the whole thing and we'll by the way covered. That's a later on in the app. But let's start with a very simple question. 

What is a hedge fund? 

So, I guess that a hedge fund is, if you think it's like a investment company, where we pull funds from accredited new investors and invest their money for them. 

But more technically, we're like, in a partnership with the investors. So they are, the investors are what? 

We call limited partners who serve solely as sign up silent partners as investors in our fund. 

And we are the general partners who contributed to the day to day management of the business of the fund. I mean, Ryan can talk about the structure of our fund Moines. 
Need details later, 
which will expand the relationship between the managers and nine investor investors better buy in general hedge funds are pulled funds that focused on getting positive returns and outperforming the 

general markets. 

So we can have all kinds of strategies, focusing on all kinds of markets. Our find is the one that focuses only on the long term. 

Investment, 

so if you think about where the name, 

like hedge fund, 

the name is from, 

it's like, 

you know, 

you basically hedge against market risks in order to outperform the market itself. 

So that's just like a quick summarize summary of the definition of a hedge fund. Yeah. And just a add onto that it is interesting because hedge fund is not a legal term. 

This is what I thought was pretty pretty funny, because nobody knows what a hedge fund his, but,
according to, 

according to Bill Eichmann who's a famous hedge fund manager,
he said,
headphone's more incentive structure is different from a mutual fund. 

Because hedge funds make most of their money from, from the incentive fee. You take a piece of the profit from the investment gains that you take mutual funds. Don't do that. They only charge a management fee. 

So that will be a big difference to distinguish mutual fund. A hedge fund, and that's kind of unique. I had no idea. Hedge funds can do that. I thought that pretty much all the investment organizations can only match. 

I mean, take the management fees these of a bunch of regulations that came up after the Great Depression. 

But that's super interesting new stuff. Sure. So, let's talk about differences between the mutual funds and hedge funds, but between the venture capital funds and hedge funds was the major difference there. 

So, to my understanding, like, VC investing business, when they're at their early stages with funds in forms of equity and debt. So they mainly look for growing companies. 
And startups, like example, would be like, Shark tank, you know, business, going on Shark tank, ask for funds to grow. And if the panelists choose to invest, they became the in the business. 

I think, on the other hand, hedge funds, focus more on, like, finish assets. We can basically investing anything like stocks,
distress,
debt, 

commodities options, 

or others we can make money when the company's building by shorting it or when the company succeeds when we're putting money, 

like investing it. 

Whereas I feel like venture capital can only profit when the company does. Well, so there is just more financial derivatives and tools such as margin. 

We have to develop our strategies, which one to invest in accompanying their later stages. And for a VC, there's more of a risk. You know, I've heard of the. 

Eighty twenty rule, which means the twenty percent of your investment makes up eighty percent of the profit. Most of the companies fell for VC. 

And if we have that record our hedge fund, you're probably not doing very well.
So, it's just differing in that way, because we have to manage our risk and loss. We have a stop loss. 

If we don't think the company's doing well, we can't sell the stocks or, like, you know, use some kind of a hedging strategy to stop our position. 

Compared to venture capital, if you invest your money, that money is in the company it's gone use. 

So it's like more extreme in my point of view but they're just like a more tools we can use as a hedge fund as well. 

We just say we don't use margin specifically for outbound because Ryan, what does the three poisons of your life? 

Yeah, there's three else that you wanna avoid ladies, liquor and leverage leverage. So,
yeah,
yeah, 

and just to add onto that, 

I think vc's and the headphones are different in the markets that you invest in a large part of a hedge fund investing in the secondary market and investing not primary markers are no startups either. 
And for you're already just betting on, maybe two out of a hundred investments are gonna make it and 
they're gonna give you five thousand times your money and the rest of your ninety eight investments that you're just gonna go bust. 

I think that's one big difference. Right. That's the major difference. And that's great. And here I want to pull up real quick on the episode that I had just yesterday there, the founder of the company raise his money through really non traditional sources. 

So, from in the team owners, really high net worth individuals and dance, you mentioned also hedge funds. So she did manage to get his funding from hedge funds. 

And my question is, do believe that hedge funds actually do invest in startups from time to time. Because I believe there are multiple ways in which this can be done. 

I think, like, you can even deploy the stocks of the startup as a collateral even if they are not registered. So, have you ever. 

Consider this, or have you ever seen this other hedge fund managers doing? 

I've seen this yeah, I've actually seen a hedge fund with, like, all sorts of primary marketing investments, but they're definitely about less than five percent. 

So, I think for hedge funds, that's not their primary goal, but it's definitely doable, but we're not considering that we're only focusing on established companies on the NASDAQ in New York Stock Exchange. 

That's just not our strategy. Also. Institutional investors don't like it when a fund started with one strategy and a shift to the other. 

So if you do that, you're not gonna be very successful at raising capital from the larger investors. Otherwise you're, you're, you're just, I don't know very convincing. Right. That's a good point. That's a good point. 

And I'm thinking, if you answer, ask some follow up questions on that, but probably, you've answered. So let's move on to the next question, which is why to do this side to start the standard capital. 

And by the way second follow up question is, why is it called standard capital. That's a good question. 

So, first of all, I the reason I started steering capital is because I received enough funds and interest my family shares basically, the same vision for investing as me. 

And my friends who I built trust with also became standard capital investors, since we're doing,
like,
long term investment, 

as our strategy time is very,
very valuable since companies grow stock prices, many companies,
grow stock prices compound with time. 
Our goal is to make money in the horizon of five to ten years. Plus, the earlier we start investing the more asset we can obtain when we make the right decision. 

So, then we'll be closer to our investment goal. And, of course, I met Ryan who possess the same investment principles as me as my partner. 

So I think it's perfect time that way, you know, shares this vision. And we just decide to do this thing as already as possible. 

And Ryan can talk to you about our why our fund is is called standard capital. 

Yeah, 

so when when we first met each other, 

it's kinda surprising that we both have the long term value investing mindset because these days people are focused on making quick money, 

you know, 

especially with the rise of quantitative trading and all the so called financial monitoring that kind of stuff algorithm trading, 

and people just don't, 

you know, 

want to have a lot of patients in a way for your investments to compound. 

And I think it's a, it's a shame because that's what investing should be about in the beginning. 

And so we wanted to start the buffet style, old school, long term compound their fund. 

So, in terms of the name oif, you'd actually be surprised how many hedge funds name already taken pretty much anything kinda thing already registered. 

So, but but that's not that's why funds call standard capital we wanted to call that, because we don't want to be anything fancy. 

The funds started by young guys typically are calling something super, Super out of the world and just, we don't want to reflect that. We don't want to show that we have a mindset. 

Of, you know, everybody down to earth focused on what works, and what has been working for hundreds of years and we want to become the standard of the investment industry and that's why we want to car ourselves, standard capital. 

Something that has both ambition and not fancy speaking of fencing names. So I'm curious here, have you, can you recall some of, like, the weirdest names of hedge funds that you've heard? 

Yeah, there's actually a fund that failed. And first, in the last couple of years called capital R billing means something like an arrow or bowl or something like that. 

And in Latin I don't know, but it's five hundred million phone that got started trade focused on short term trading on commodities. And obviously, that failed dramatically. 
So so, yeah, that's found your million dollar fund just like that. 
And so, yeah, here's there's a lot of funds out there doing short term trading stuff and it's it's very, it's very dangerous, especially all of them use leverage. 

So, once you use leverage and volatility kicks in, you are, you know, you better have a good hedge or just gonna close shop. 

Right, 

right and yeah, 

short term investing in commodities that sounds pretty fun to be honest, 

but let's move on and talk about another question dialogue specifically young entrepreneurs, 

we're young, 

you know, 

financial background people face. 

So question is, should I go into these, you know, standard financial fields? So, investment banking, private equities, et cetera, hedge funds or should I go into investing in the startup? 

So who do you think should consider investing starts and who should consider investing and securities and other financial instruments? Yeah. So I think it depends on your risk tolerance. 

Like I said earlier investing startups is very risky. Probably the most risky investment to make your most investments. 

Are probably gonna go bust,
but depending on the hedge fund or other, whatever security's you invest in,
depending on their strategy,
a lot of them will have a much safer strategy for us, for example,
standard capital,
only investing,
financially healthy,
essential companies.
And by doing this. We want to achieve. 

Capital appreciation and preservation at the same time, but if you invest in startups, you probably don't have capital preservation as a priority. You just want appreciation. So that's a trade off right there. 
If you're more risky kind of guy, you wanna. Maybe you wanna do startup investing like most of you, 
she saw he invested in ninety bubbling, twenty million dollars. Now. It's like, I don't know, fifty billion or something like that. 

It's, it's a hit or miss wash actually is more of a miss than hit. But you just gotta you just gotta hit a lot so but yeah. Dependent. 

Yeah, 

my my hedge funds are definitely more risky than your traditional mutual funds or other annuity kinda stuff, 

but if you pick the right funnel with a safer strategy, 

it's it's definitely a lot better if you're risk averse. 

So, depending on a risk profile. Absolutely. Right. 

And I think I'll title this episode, you know, hedge fund managers, make fun of VC investors, but definitely I, I think it's, it's not necessarily everybody has their own circle of competence. 

You just do what you, you know, what you're good at. So. 

Absolutely, absolutely. And speaking of being good at something, I assume that you've acquired plenty of knowledge, in terms of starting a hedge fund, so actually organizing it etc. Etc. What do you think is the major issue there when you decided to go out and raise your own hedge fund? 

What's the major constraints there? Yeah, so specifically for us is the age thing no matter how great your track record is. 

If you are twenty five years old people are gonna think you're a baby, you want to raise money for a hedge fund. They just tell you to get out. 

And so, for us, the strategy is, we don't even approach institutional investors for the first three years. 

We just approach our own connections, the people that we know through our lives, and they are more trustworthy in us and they're more likely to give money to us. 

So that's a that's a big hurdle for us. Ach. 

And I'm assuming if you're in your thirties or forties, if you can put put together five to ten million dollars, at least there's probably a issue somewhere down the line. You probably aren't. 

Aren't probably aren't fit for doing this, 

but if you are in your forties and you wanna raise money from the institutional investors, 

you probably need to track record. 

That's that's true. That's your biggest thing. And if you have a bad track record, that's gonna be a biggest hurdle and everything else says should be. Okay, right right. Good point. 

The age is probably one of the major reasons for why I left this traditional financial field and went to the start field, because they're pretty much. No one cares about that. So, good point. Very good point here. 

Let's move onto the actually raising those funds and comparing the process of fundraising for a hedge fund versus a startup or venture fund. What's the best way? 
What's basically the major way of you finding new connections, you know, in this financial field? Find new intro past to the investors how do you usually do this? 

Yeah, I think personally, my best way of getting in connection is to get your foot in the door of a financial institution for me, I've done into J. P. 

Morgan is my first job,
if you can't get into the front office positions, 

because they're too hard and competitive try middling back office and try switching around either switching companies or switching positions within your company. 

You gotta put yourself out there and be nice at the very beginning. 

Like, I always say the actual fundraising process starts way before your fundraising process, you need to leave a good impression on people and build relationship from day one. 

So people know who you are, and people build trust over time if you're rude and shy all the time. But when you start your fundraising process and instantly change to, like, the nicest guy ever, that's gonna be very easy to tell. 

Absolutely and yeah, it's like, building a it's like, planting a tree. It takes time. And if you do arrive, they should, it should get easier. Also. 

Those people are gonna refer you on their own connections, which is another way to get new connections. If people refer you to other people, they automatically have more trust, because they have a mutual friend. 

So that's gonna be a that's one of the ways. It's gonna be tremendously helpful. Absolutely. I mean, it seems like the fundraising poses here are pretty similar. 

The same is the exact advice I'm giving to every start founder, you know, you should start raising money, like a year before you actually start raising money, just by building those connections and being, you know, nice to people here. 

We're moving onto last question of the day's episode, which is a call to action. So, what's the one thing you believe that? The listener should do as soon as the episode is over and by the way keep in mind that. Most of my listeners are start founders. 

And executives not hedge fund managers. I think if you want to start a business, even it's not a hedge fund,
or, 

like,
just have any variation being a president, or,
like, 
save the planet Earth, 
just don't hesitate start now and figure out later I didn't really know much about how to start a headstrong before I start doing it don't get me wrong. 

I know all about investing by still learning a lot when I get hands on starting the business. So just don't wait. It's never too early. It's never too late. Just do it. 

Do do do whatever you can like starting from now. 

Yeah, my my advice would be think of it as a chest scan right? You have to make so many moves to get to the endpoint and be nice. 

And the start, it's one of your most try to find out who is worthy of getting connected, try to reach out to those people and build relationships may make a move. Absolutely. 

And just one more last full up for this episode, this making connections, and, you know, reaching out to people who are worthy of making connections with. So what's the best way of approaching these people? 

So let's say, I don't really have any specific, I know mutual beneficial tasks for them or something or collaboration or anything like that. How should I approach that person? 

Should I'd be like, hey, I just wanted to connect with you because, you know, in the future that might be helpful or what's the best way to do? Is basically. 

If you can meet them face to face, which is what happened to me and a lot of my new connections, I was able to meet in person and try to approach them and introduce yourself. 

Those connections are typically a lot older than me. Here might not be a lot of common ground for topics, but there should be a sound from like sports or or stocky. 

Like, for example, there were a few people in my past from who were a lot older than me. 

But they're all doing investing and as soon as I open the mouth, so there were just a lot of topics to talk about and we bonded pretty well and we still remain great connections with friends, right? 

Yeah, that I come on ground, that's it's honestly not that hard to find, especially if, you know, like, what what's what kind of people are in the room. So, yeah, I just take your time to do that. But me, do you have your personal approach to this problem? 

I think definitely, for the older generation, they really appreciate if you just ask them, you know, go out for a beer meet face to face the one of the investors I met in New York. 

He was actually actively saying that he's really appreciate that. It's like my father's connection actually, and I met him and he's really appreciate that. 

I actually took the time to meet him and grabbed be socializing, rather than just do, like, a very, you know, like a business, formal phone call and I'm just and I think all of your connections that are very important. 

Even their potential investors. Their friends could be, so just be mindful always talk about what you're interested in what you're doing about your business. 

Someone's gonna be interested in in the same things you're doing, and refer you to their friends or their family, their connections. 
So, 
my advice would be just, 

like, 

talk about your interests, 

your business constantly and make a fun and try to socialize be respectful meet the people as often as you can to establish the connection. 

Perfect yeah, 

that's a perfect advice and yeah great call to action, 

you know, 

at the end boils up to being nice to pretty much everyone even if you don't see, 

like, 

extreme use them specifically, 

at this exact moment, 

but we're gonna wrap it up my call to action is going to be as usually go to descriptions this episodes for this episode. 

I'll try to include some books on investing securities and I'll ask Brian and me to send me a couple a couple of their favorite books for these topics. 

So, if you're curious how that world works versus the startup world, definitely take a look at the descriptions this episodes there's going to be something interesting to read there and have a good day.