Hedge Fund Styles
While more than 70% of the total assets under management in hedge funds are
invested in the equity markets, the investment disciplines are diverse and distinct.
HedgeWorld uses the Credit Suisse Tremont Index
LLC's series of
sub-indices, which are designed to track the primary categories of investment
styles used by hedge fund managers.
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Convertible Arbitrage
This strategy is identified by hedge investing in the convertible securities of a
company. A typical investment is to be long the convertible bond and short the
common stock of the same company. Positions are designed to generate profits from
the fixed income security as well as the short sale of stock, while protecting
principal from market moves.
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Dedicated Short Bias
Dedicated short sellers were once a robust category of hedge funds before the long
bull market rendered the strategy difficult to implement. A new category, short
biased, has emerged. The strategy is to maintain net short as opposed to pure short
exposure. Short bias managers take short positions in mostly equities and derivatives.
The short bias of a manager's portfolio must be constantly greater than zero to be
classified in this category.
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Emerging Markets
This strategy involves equity or fixed income investing in emerging markets around the
world. Because many emerging markets do not allow short selling, nor offer viable
futures or other derivative products with which to hedge, emerging market investing
often employs a long-only strategy.
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Equity Market Neutral
This investment strategy is designed to exploit equity market inefficiencies and usually
involves being simultaneously long and short matched equity portfolios of the same size
within a country. Market neutral portfolios are designed to be either beta or currency
neutral, or both. Well-designed portfolios typically control for industry, sector,
market capitalization, and other exposures. Leverage is often applied to enhance returns.
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Event-Driven
This strategy is defined as equity-oriented investing designed to capture price movement
generated by an anticipated corporate event. There are four popular sub-categories in
event-driven strategies: risk arbitrage, distressed securities, Regulation D and high
yield investing.
- Risk Arbitrage: Specialists invest simultaneously in long and short positions in
both companies involved in a merger or acquisition. Risk arbitrageurs are typically long the stock of the company
being acquired and short the stock of the acquirer. The
principal risk is deal risk, should the deal fail to close.
- Distressed Securities: Fund managers invest in the debt, equity or trade claims of
companies in financial distress and generally bankruptcy. The securities of companies in
need of legal action or restructuring to revive financial stability typically trade at
substantial discounts to par value and thereby attract investments when managers perceive
a turn-around will materialize.
- Regulation D, or Reg. D: This subset refers to investments in micro and small
capitalization public companies that are raising money in private capital markets.
Investments usually take the form of a convertible security with an exercise price that
floats or is subject to a look-back provision that insulates the investor from a decline
in the price of the underlying stock.
- High Yield: Often called junk bonds, this subset refers to investing in low-graded
fixed-income securities of companies that show significant upside potential. Managers
generally buy and hold high yield debt.
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Fixed Income Arbitrage
The fixed income arbitrageur aims to profit from price anomalies between related interest
rate securities. Most managers trade globally with a goal of generating steady returns with
low volatility. This category includes interest rate swap arbitrage, US and non-US government
bond arbitrage, forward yield curve arbitrage, and mortgage-backed securities arbitrage.
The mortgage-backed market is primarily US-based, over-the-counter and particularly complex.
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Global Macro
Global macro managers carry long and short positions in any of the world's major capital or
derivative markets. These positions reflect their views on overall market direction as
influence by major economic trends and/or events. The portfolios of these funds can include
stocks, bonds, currencies, and commodities in the form of cash or derivatives instruments.
Most funds invest globally in both developed and emerging markets.
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Long/Short Equity
This directional strategy involves equity-oriented investing on both the long and short sides
of the market. The objective is not to be market neutral. Managers have the ability to shift
from value to growth, from small to medium to large capitalization stocks, and from a net long
position to a net short position. Managers may use futures and options to hedge. The focus may
be regional, such as long/short US or European equity, or sector specific, such as long and short
technology or healthcare stocks. Long/short equity funds tend to build and hold portfolios that
are substantially more concentrated than those of traditional stock funds.
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Managed Futures
This strategy invests in listed financial and commodity futures markets and currency markets around
the world. The managers are usually referred to as Commodity Trading Advisors, or CTAs. Trading
disciplines are generally systematic or discretionary. Systematic traders tend to use price and
market specific information (often technical) to make trading decisions, while discretionary
managers use a judgmental approach.
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