Should you invest in companies or funds?

Pros & cons of two approaches

Apple VS Renaissance

Consider two scenarios:

Alice invests in Apple

Alice buys Apple shares.

Steve Jobs increases share price by growing Apple revenue.

Alice sells Apple shares.

Alice invests in Renaissance Technologies (a hedge fund)

Alice deposits capital to Renaissance Technologies.

Renaissance Technologies increases capital by running a complex trading algorithm that buys and sells Apple shares (among other companies).

Alice withdraws capital from Renaissance Technologies.

The end result is the same: Alice receives profit from trading Apple shares. So, which scenario is better?

Investing in a hedge fund allows you to withdraw capital at any time (or after certain period).

Investing in a hedge fund gives you a diversified portfolio protected with stop-losses (= lower risk of losing entire capital).

Investing in a hedge fund offsets your profit by management fee.

In short, investing in a hedge fund gives you much better terms for acceptably lower profit — which seems like a prudent investment. So why don’t more people invest in funds rather than companies?

Seems like they do because they understand it better. Investing in a company with a transparent business model is just easier for the brain, whereas investing in a fund with blackbox trading strategy just seems more complex. Their mind shies away from complexity and clings to familiar concepts, which is quite irrational.

Good news is that you can use this irrationality to your advantage. Since not so many people invest in hedge funds, you can get better risk-adjusted returns by investing in their trading strategies. And to choose the right strategy, you only need to pay attention to a handful of metrics. Which ones? I’ll describe in the next article.