This hedge fund is targeting the investor other funds don’t want

Updated on

Most hedge funds are trying to grow as large as they can with as many assets under management as possible, but one fund is bucking the trend. Fate Capital is just starting up, and it was founded with the average investor in mind—rather than just high net worth individuals.

Get The Full Series in PDF

Get the entire 10-part series on Charlie Munger in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

Q3 2020 hedge fund letters, conferences and more

A hedge fund for the average investor

Of course, to invest in hedge funds, you have to be an accredited investor, which currently means a net worth of at least $1 million or $200,000 in annual income ($300,000 for couples). This definition is being expanded to include professionals with certain licenses, which should increase the number of potential investors Fate Capital can target.

Fate Capital founder Haris Khurshid sat down with ValueWalk to talk about his philosophy and strategy for the fund. He said their main goals are to provide a fund for the average investor and to provide income streams by collecting premiums on investments.

He noted that on average, investors only earn about 3% per year from dividends. However, by writing options, he estimates that it's possible to pack on another 20%+ per year just in premiums. The point of this strategy is to increase passive income while also reducing overall portfolio risk and volatility. The strategy aims to deliver greater returns compared to other firms with the same holdings.

Fate Capital aims to stay small

Khurshid said they don't neglect value-based small to mid-cap companies, which can offer great long-term returns. The fund is designed to protect capital by minimizing risk in the equity market and portfolio using options strategies.

One other interesting thing about Fate Capital is that Khurshid aims to keep it small and avoid "asset bloat," which he believes degrades the ability to generate alpha. Unlike other funds, which have high minimum investments, the minimum investment with Fate Capital is only $100.

Khurshid said when funds reach billions of dollars in assets under management, they become illiquid. They plan to close the fund with $50 million to $75 million in assets under management by the end of the year. The fund doesn't charge a management fee, and it only shares in the profits after a return of at least 5%.

"We only win and make money if our clients make money," he said.

Enabling average investors to buy options

Fate Capital targets overlooked investors who can trade but can't find vehicles to pool their money. Khurshid added that no robo-advisors offer that, and if people are investing through financial advisors, they might not be investing a lot of money. Fate Capital offers a way for the average investor to trade options when they otherwise couldn't afford to do so.

"A lot of people don't understand the concept of writing options because it requires you to put in a lot of money up front," Khurshid explained. "You have to buy 100 shares to write an option contract. A lot of people can't afford that, especially the younger generation."

With their strategy, investors can just invest $500, $1,000 or $5,000. Then when they write the options contract on those shares, investors get paid according to how much they have invested.

How the strategy works

The fund will keep a bucket of 10 to 20 stocks and collect premiums on the holdings. It's designed for low turnover and active hedging. Khurshid explained that they write options contracts weekly or biweekly, depending on what they expect the market to do. That's how they reduce risk every week.

They also look at each company's trading volume, volatility, and premium pricing and if they have any upcoming news. Khurshid said they are very much a long-term fund as the positions are meant to be kept in the portfolio for three to five years.

To explain his strategy, he said on a stock that trades between $90 and $105, and they could write a call option for $102 and collect a couple hundred of premium and sit on it for a week. He said they look for a strike price that probably won't be exercised within the timeframe allotted.

Stock selection

In choosing stocks, Khurshid starts by gathering industry data and understanding market conditions while examining the macro view and anticipating change sin consumer behavior. He then narrows down the universe using financial metrics and proprietary models and eliminates underperforming businesses and sectors.

Then he performs fundamental research and looks for potential catalysts and drivers of future earnings that the market might have over or underestimated compared to their analysis. He then selects companies where growth might be priced cheaply or where it's trading for less than its intrinsic value.

Khurshid chose Activision Blizzard as an example. His goal is to look for absolute zero risk within a year of their original investment date. He sees four possible scenarios for what happens after they invest.

Fate Capital: Four scenarios for stock price movement

The best-case scenario is that Activision rises gradually over time. In this case, they keep the strike price relatively close to the current stock price to collect the maximum premium. Another possibility is that Activision tanks suddenly and then starts to rise gradually. In this situation, premiums will tend to increase due to increased volatility.

The third scenario is that Activision suddenly increases and then keeps rising gradually. Khurshid describes this scenario as "tricky" because it could knock them out of their long-term position if it isn't handled correctly. However, he also said the probability of this happening is low.

The fourth scenario is that Activision gradually decreases and then gradually increases, which he also said is unlikely to happen. Usually stocks that do this are cyclical, slow growth companies or companies with a new product that the market can't understand or value properly. They keep collecting premiums as usual in this scenario.

Year to date through Oct. 2, Fate Capital is up 41.5%. Khurshid noted that the SPDR S&P 500 ETF is up only 4.36%. Collecting premiums contributed 37.14% of their year-to-date gain.

This article first appeared on ValueWalk Premium.