HEDGE FUND STRATEGIES
INTRODUCTION
Hedge Fund form an important subset of alternative investments. Investment in hedge funds would result in ample additional benefits for alpha and portfolio diversification to warrant a high level of fees.
- Pros – HF managers huge talent – the broader universe – ability to generate alpha even in down markets.
- Cons-higher fees, complex documentation, lack of transparency, lack of liquidity, higher cost of maintenance.
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RISKS OF DIFFERENT HF STRATEGY AREAS
• Arbitrage Funds–leverage
• Equity and Event-driven – although lower beta, but due to higher expense, there is embedded beta
• Managed futures and global macro – although diversification but higher return volatility,
• Strategies designed to tackle tail risk (like long volatility) – underperform in normal markets.
• Some HF strategies are diversifiers while others are just return enhancers
CLASSIFICATION OF HEDGE FUND STRATEGIES:
Single Hedge fund strategies are categorized into 6 categories :
1. Equity
2. Event-Driven
3. Relative Value
4. Opportunistic
5. Specialist
6. Multimanager
DIFFERENT HEDGE FUND STRATEGIES USED:
EQUITY:
Equity related hedge fund strategies focus primarily on the equity markets, and the majority of their risk are equity-oriented. The alphas related to equity strategies tend to derive from the wide variety of equity investments available globally. The size and sign of equity market exposure often dictate the classification of equity hedge fund strategies. Within this equity-related hedge fund strategies, the main strategies are:
• Equity market Long/ Short Equity
• Dedicated short bias
• Market neutral
EVENT-DRIVEN STRATEGY:
This is a hedge fund strategy whereby a hedge fund will be involved in major corporate activities that can have a substantial impact on the company’s value. These activities include IPO, merger, acquisition, restructuring, financial distress, shareholder buybacks, governance events. The primary risk for this strategy is event risk, the possibility that an unexpected event will negatively affect a company or security.
It majorly focuses on corporate events like:
•Merger Arbitrage
•Distressed Securities
RELATIVE VALUE STRATEGY:
The relative value hedge fund strategy focuses on the relative valuation between two or more securities. These strategies are often exposed to credit and liquidity risks because the valuation differences from which these strategies seek to benefit often are due to the difference in credit quality or liquidity across different securities. Only sophisticated managers are capable of taking these risks. This hedge fund strategy attempts to take advantage of price discrepancies between financial instruments.
It focuses on the relative valuation between two or more securities:
. •Fixed Income Arbitrage
•Convertible Bond Arbitrage
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OPPORTUNISTIC:
This strategy takes a top-down approach, focusing on a multi asst opportunity set and relates to trading activities based on the manager’s view of economic drivers and political changes that can have an impact on the markets. Global macro managers can employ a variety of techniques and asset classes to capitalize on changing market environments. However, even though the global macro strategy can generate substantial returns, the risk involved is high as its strategies depend on the opportunity set involved and can vary across time and asset classes.
The two common opportunistic hedge fund are as follows:
•Global Macro
•Managed Futures
SPECIALIST:
Specialist hedge fund strategies focus on special or niche opportunities that often require a specialized skill or knowledge of a specific market. The strategies can be exposed to unique risks that evolve from particular market sectors.
There are two major specialist hedge fund strategies:
• Volatility Strategies involving options
• Reinsurance Strategies
MULTI MANAGER:
Multi-strategy funds Strategies focuses on building a portfolio of diversified hedge fund strategies. Managers in this strategy use their skills to combine diverse strategies and dynamically re-allocate among them over time and use several different processes within the same pool of assets. The biggest benefit of this approach is that the fund becomes broadly diversified. Diversification helps smooth performance and reduces the volatility of a portfolio. On the other hand, the performance may become diluted and yield unattractive returns.
It generally focuses on building a portfolio of diversified hedge fund strategies
•Multi-strategy
•Fund-of-Funds
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Author: Bhagyashree Chandak
About the Author: I aspire to become a research analyst and earn and use the best of my knowledge.
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