Secrets of Hedge Funds: How Billionaires Gamble Without Losing

Back in the 1950s, a sociologist named Alfred Winslow Jones had an idea that would change investing forever. He wasn't a Wall Street banker or a stock broker. He was a thinker.

And what he created was the very first hedge fund. Now, what does hedge actually mean? Well, simply put, it means protection.

It's like when you buy a plane ticket with travel insurance. If the flight gets cancelled, you lose the ticket, but the insurance pays you back some of that money. But Jones applied this idea to investing.

He placed bets on companies he believed would succeed and at the time bet against companies he thought would fail. The goal was to balance the risk no matter which way the market moved. Fast forward to today and hedge funds have become well pretty much the opposite of what Jones intended.

They're often high-risk deals behind closed doors where only a select few are allowed in. So what happened? Well, let's take a look at how modern hedge funds actually work.

Welcome to Alux, the place where future billionaires come to get inspired. So, modern hedge funds are private investment vehicles reserved for the ultra wealthy. They're exclusive, lightly regulated, and can pretty much do whatever they want.

But to understand how that's even possible, you first have to know how the government tries to protect you from going full degenerate and blowing up your life savings. And it all goes back to the 1920s. The US economy was booming.

Companies like Ford revolutionized manufacturing with the assembly line, which meant faster production, cheaper goods, and booming productivity across industries. People had jobs. Wages were up.

Stuff was cheap. For the first time, people were buying cars, radios, fridges, washing machines. Modern life had arrived.

Things were going suspiciously well. Maybe too well. Investing became America's national sport.

Everyone was jumping into the stock market like it was a guaranteed way to get rich. People were borrowing money to buy stocks. There were no rules about insider trading, fake companies, or price manipulation.

No one checked if the company you bought stock in actually existed. It was a casino. People just went with the idea that the market will always go up.

And by the way, if you're wondering, well, actually, does the market always go up? Well, we've got a video on that. Link is in the description.

Anyways, back to the 1920s. Stock prices soared. Company valuations were detached from reality.

People were investing in gold mines that didn't exist, airline companies with no planes, and cactus farms. In New Jersey, there were no watchd dogs, no verified information, just hype, hope, and fraud. Then came October 1929.

People realized they were investing in magic pixie dust. So, they started panic selling. The market lost nearly 90% of its value over the next few years.

Banks failed. Businesses closed. Millions lost their life savings.

This crash triggered the Great Depression, one of the darkest economic periods in modern time. Now, to prevent another disaster, Congress stepped in. First came the Securities Act of 1933.

It forced companies to tell the truth about their financials when selling stock. Then came the Securities Exchange Act of 1934. It created the SEC, which stands for the Securities and Exchange Commission, a government agency to oversee markets, enforce rules, and protect investors.

So these days, if you want to invest in a company, you get real financial data, verified reporting, and equal access to information. You can still make risky bets under this, but now at least you know if the company actually exists. And this gave us two major things.

First of all, it gave us transparency. everyone can see how public companies are doing. And second of all, fairness.

Everyone plays on the same field. So, how do you get ahead if everyone plays fair? Well, by accessing tools not everyone is using by building skills not everybody has.

And the Alux app will secure both of them for you. We go out there and we find the most capable people in the world, pay them a fortune to coach our community, and give you access to it under a single subscription. And because it's digital, we can give it to you for cheaper than a gym membership.

Go to alux. com/app right now and download the app and see why over 250,000 CEOs, entrepreneurs, managers, and creators are using it. Even better, scan this QR code after it's downloaded and you'll get 25% off the annual subscription.

But that's enough self-promotion for today. All right, let's dig into the good stuff. Welcome to modern-day hedge funds.

So after the 1929 stock market crash, Congress introduced strict regulations to protect everyday investors. But what if you didn't want to follow those rules? Simple.

You avoid the public market entirely. And that's where hedge funds come in. So hedge funds are private.

They don't raise money from the general public. To invest, you have to be what's called an accredited investor. That's a legal term that basically means you're rich.

Usually, it means you've got over a million in net worth, excluding your home, or you make over $200,000 a year. This is how hedge funds legally avoid public market rules. The law assumes that if you're wealthy, you can afford to lose money and you don't need the same protections as everyone else.

It's basically a legal loophole. A hedge fund is technically speaking not a fund. It's just a group of people with a lot of available cash.

So all the rules and regulations that Congress made don't apply to them because they don't operate in the public market. That's essentially the whole point of a hedge fund. A hedge fund works like this loosely.

So a bunch of wealthy people pull millions of dollars into a partnership with a fund manager. The manager takes that money and says, "Trust me, bro. " And heads off into the financial wilderness for a year or two.

It's a let him cook kind of situation. Nobody really knows what they're doing, not even investors. There's no daily updates, no public reports, and no real oversight.

Then hopefully the manager comes back with more money than they left with. This leads to an obvious question, though. If public markets are regulated to be transparent and fair, why would wealthy people choose to opt out of that system?

Well, the answer is freedom. Hedge funds aren't just buying and holding Apple stock hoping the new iPhone is going to be the best iPhone yet. No, hedge funds can bet on interest rates in Japan, the collapse of a real estate fund in China, or the spread between oil and natural gas futures in Texas.

They also invest in assets most people can't even access. Private loans, distressed companies, rare artwork, niche real estate deals. If something has a price, someone is trading it.

These are not your Robin Hood style investments. No, hedge funds operate in markets that are off limits to the average investor, and they trade things most people never have heard of. They can also take on risks that public funds simply are not allowed to, like heavy leverage, exotic derivatives, or shortselling entire economies.

These are strategies that would get a mutual fund manager fired, but in a hedge fund, they're just your average Tuesday. Imagine investing like fishing. Public markets like mutual funds, index funds, regular stocks, these are like fishing off a crowded dock.

The water is clear, everyone can see each other's bait, and you can jump in and out whenever you want. It's safe, it's slow, and it's transparent. But catching something rare is almost impossible.

Now, picture a hedge fund. It's a submarine, a small, highly trained team with sonar, secret maps, and advanced gear, diving into deep waters that nobody else can reach. They stay submerged for weeks, make strategic moves that no one can see.

And if there's something valuable down there, they'll find it and grab it before anyone on the dock even knows it exists. Unlike mutual funds, hedge funds don't have to tell you what they own. There's no obligation to disclose what they're buying, how much they've bought, or when they've sold it.

Now, first of all, they don't want competitors copying their trades. Hedge funds spend millions developing research and models. If their moves were public, others could just copy paste their strategy for free.

Second, market impact matters. If people know a hedge fund is buying a specific stock or asset, the price could spike before the fund finishes buying, which hurts their performance. The same goes for selling.

If other investors catch wind of a hedge fund exit, it could trigger a panic cell. Then there's the issue of liquidity. When you invest in a hedge fund, you can't just pull your money out anytime.

Most hedge funds have lock up periods of 6 months, a year, or even more. That's because they often invest in things that can't be sold quickly or easily. If everyone tried to withdraw their money at once, well, the fund might be forced to sell assets at fire sale prices, hurting everyone involved.

And lockups also give the manager the ability to let their strategies play out. Some bets take months or even years to mature. If investors can yank their money out too early, it disrupts everything.

And finally, the part that really sets hedge funds apart. The manager almost always gets paid. Regardless of whether the fund performs well or not, hedge fund managers typically earn a fortune.

Unless they completely crash and burn, they collect massive fees, which leads us directly into one of the most controversial aspects of the hedge fund world, and that's the 2 and 20 rule. So, at the heart of almost every hedge fund is something called the 2 and20 fee structure. It's the standard compensation model that's made many hedge fund managers, billionaires, even when their investors walk away disappointed.

So, here's how it works. So, the two stands for a 2% management fee, and the 20 stands for a 20% performance fee. On paper, that might not sound outrageous, but when you look at the actual numbers, it's easy to see how incredibly lucrative this system really is for managers.

Whether the fund makes money or loses money, the manager collects that 2% just for managing the assets alone. It's like a subscription fee, but instead of paying Netflix 10 bucks a month, you're paying millions just to have your money in the room. So, let's put it to some real numbers here.

If a hedge fund manages $1 billion, that 2% management fee alone brings in $20 million a year. That's before the fund makes a single dollar in profit. Even in years where the fund loses money, that manager still collects the full 2%.

Hedge fund managers also get to take 20% of any profits the fund makes. So if the fund has a great year and earns $100 million in returns for investors, the manager gets to pocket 20 million of that. So, combine the two, the 2% management fee and the 20% performance cut, and you have a compensation model where the fund manager gets rich in almost any outcome except total disaster.

And here's the kicker. The investor takes all the risk while the manager still walks away with a guaranteed income. If the fund loses money, it's your loss.

If it makes money, you split the profits. But either way, the manager gets paid. Now, there are some mechanisms in place that try to make this fairer, like the high water mark.

This rule says a fund manager cannot take the 20% cut again until the fund regains its previous peak value after a loss. So, if a fund drops in value one year, the manager doesn't get to collect performance fees the next year until they've made up for those losses. And that sounds fair in theory, but in practice, it doesn't change the fact that the 2% management fee still rolls in regardless of performance.

And over time, this adds up to incredible wealth for all of the people running these funds. Now, some hedge funds charge even more than 2 and 20. And while investors can try to negotiate their fees, especially if they're contributing large amounts, the basic structure remains the same.

The house always wins. And this is one of the reasons why hedge funds have come under criticism, especially in recent years when many of them have failed to outperform simple index funds. Investors look at the fees, the secrecy, and the high risk, and they ask, "Wait, why are we paying so much when we could just buy an ETF that tracks the market for a fraction of the cost?

" It's a fair question. The 2 and20 model worked back when hedge funds consistently delivered what's called alpha returns above the market average. But over the last decade, many hedge funds have struggled to do that, especially after fees.

Yet, despite all of this, hedge funds continue to raise billions from wealthy individuals, pension funds, endowments, and institutions. Why? Well, because while the performance might be inconsistent, the access, exclusivity, and potential for asymmetric returns still attract the elite.

And because for the ultra wealthy, hedge funds offer something more than just financial performance. Which brings us to our final question today. If hedge funds are high risk, high fee, and often underperform, then why do the rich still keep coming back?

In Alfred Jones's world, hedge funds were a strategy to minimize risk. But today, a hedge fund is more like a private club for rich people. If you were pitched a product that charges high fees, locks up your money, keeps you in the dark about what it's doing, and might not even beat a basic index fund, you'd probably pass, right?

So, why don't rich people? Why do the ultra wealthy, the people with access to the best financial advisors, the most advanced data, and every investment option under the sun, still put billions into hedge funds? It's not just about chasing returns.

It's about something deeper, something cultural, psychological, and strategic. So, let's break it down. Okay, first of all, hedge funds offer access to strategies that most people will never see.

This includes highfrequency trading algorithms, global macroeconomic plays, bets on political outcomes, interest rate shifts or regulatory moves, complex derivatives, and private market opportunities that don't show up on any stock exchange. These are not things you can buy with your online brokerage account. Hedge funds operate in parts of the market that are often out of reach for traditional investors, and that exclusivity is part of the appeal.

For the ultra wealthy, investing isn't just about earning 6% or 7% a year. It's about gaining access to things that can't be indexed. Hedge funds are one of the few places with asymmetric risk.

And if you don't know what that means, we've got a great video about it, okay? The link is in the description. It's the kind where you risk $1 to make $10.

Most of those opportunities don't exist in public markets anymore. Hedge funds, they're out there hunting for them even still. Then there's the issue of time and convenience.

For many wealthy individuals, managing a portfolio full-time just isn't practical. Hedge funds allow them to offload the responsibility of finding unique opportunities to somebody else. They're paying not just for returns, but for mental bandwidth.

Think of it like this, okay? Hedge funds are the financial equivalent to a private chef. Could you cook your own meals?

Of course you could. But would they be as good as someone trained at a Michelin star kitchen with access to rare ingredients? Probably not.

Next, networking and social capital. This is the hidden value of hedge funds and maybe the most important part. Hedge funds operate like private clubs.

Getting in means access to other investors, strategic relationships, insider deal flow, and social positioning. Being a limited partner in a top tier hedge fund isn't just an investment decision. It's a badge.

It says, "I have access. I am part of this circle. I get to hear things before the rest of the world does.

" You won't find that on a brokerage app. There's also risk diversification. Wealthy investors already have real estate, stocks, private equity, art, maybe even their own business.

Putting a slice into hedge funds with strategies that don't move the same way the market does helps to spread the risk out a little bit. Even if the fund underperforms, it might reduce overall portfolio volatility. And for some, that's worth it.

Then there's the cultural aspect. Hedge funds still hold a certain mystique, right? They're portrayed in movies and headlines and pop culture as the financial elite's secret weapon.

The idea that you might be connected to the next Renaissance Technologies or a Citadel, the ones generating billions in profits through secrets and science is powerful. And even if most hedge funds don't hit a home run, the hope is that you're in the one that does. Ultimately, it's about legacy, power, and status.

Hedge funds offer a layer of strategic control over capital that isn't available in basic investments. They can align with tax strategies, estate planning, geopolitical bets, even philanthropic plays. Being part of a hedge fund means being part of the ecosystem where wealth is created, protected, and moved behind closed doors.

Hedge funds started as a way to reduce risk. A clever idea from a sociologist who wanted to balance fear and greed in the market. But over time, they evolved into something very different.

They operate in a world that most people never see. A world with fewer rules, more tools, higher rewards, but also higher risks. They can win big or lose big and disappear overnight.

And yet, despite all of that, money keeps flowing in. Hedge funds are not about returns. They're about access to a room where bigger deals are being made.

For most of you, that room is the public market. safe, regulated, and transparent by design. And it's not a bad thing.

It's the result of lessons learned the very hard way. So, next time you hear about a hedge fund making billions or collapsing in flames, you'll understand what's really happening behind the curtain. Thanks for spending some time with us today, Aluxer.

We'll see you back here next time. Until then, take care, my friend.