Hedge Fund Strategies
Similar to categorizing alternative investments, classifying hedge funds can also be challenging. According to Hedge Fund Research, Inc., there are four main classifications of hedge fund strategies:
1-Event-driven strategies
Event-driven strategies ⇒ are typically based on a corporate restructuring or acquisition that creates profit opportunities for long or short positions in common equity, preferred equity, or debt of a specific corporation. Event-driven funds are typically long-biased.
Subcategories are as follows:
- Merger arbitrage: Buy the shares of a firm being acquired and sell short the firm making the acquisition. Although term “arbitrage” is used, such a strategy is not risk free because deal terms may change or an announced merger may not take place.
- Distressed/restructuring: Buy the (undervalued) securities of firms in financial distress when analysis indicates that value will be increased by a successful restructuring; possibly short overvalued securities at the same time.
- Activist shareholder:Buy sufficient equity shares to influence a company’s policies, with the goal of increasing company value (e.g., by restructuring, change in strategy/management, or return of capital to equity holders).
- Special situations: Invest in the securities of firms that are issuing or repurchasing securities, spinning off divisions, selling assets, or distributing capital.
2- Relative value strategies
Relative value strategies ⇒ involve buying a security and selling short a related security, with the goal of profiting when a perceived pricing discrepancy between the two is resolved.
- Convertible arbitrage fixed income: Exploit pricing discrepancies between convertible bonds and the common stock of the issuing companies and options on the common shares.
- Asset-backed fixed income: Exploit pricing discrepancies among various MBS or asset-backed securities (ABS).
- General fixed income: Exploit pricing discrepancies between fixed-income securities of various issuers and types.
- Volatility: Exploit pricing discrepancies arising from differences between returns volatility implied by options prices and manager expectations of future volatility.
- Multistrategy: Exploit pricing discrepancies among securities in asset classes different from those previously listed and across asset classes and markets.
3- Macro strategies
Macro strategies ⇒ are based on global economic trends and events and may involve long or short positions in equities, fixed income, currencies, or commodities. Managed futures funds may focus on trading commodity futures (these funds are known as commodity trading advisers, or CTAs) or incorporate financial futures.
4- Equity hedge fund strategies
Equity hedge fund strategies seek to profit from long or short positions in publicly traded equities and derivatives with equities as their underlying assets.
- Market neutral: Use technical or fundamental analysis to select undervalued equities to be held long and to select overvalued equities to be sold short, in approximatelyequal amounts to profit from their relative price movements without exposure to market risk. Leverage may be used.
- Fundamental long/short growth: Use fundamental analysis to find high-growth companies. Identify and buy equities of companies that are expected to sustain relatively high rates of capital appreciation, and short equities of companies expected to have low or no revenue growth.
- Fundamental value: Buy equity shares that are believed to be undervalued based on fundamental analysis and sometimes short an index or companies believed to be overvalued. Exposures to value stocks and small-cap stocks often result.
- Sector specific: Identify opportunities within a sector, such as health care, biotech, technology, and financial services. Manager expertise within a specific sector is believed to lead to superior returns.
- Short bias: Employ technical and fundamental analysis and take predominantly short positions in overvalued equities, possibly with smaller long positions but with negative market exposure overall.