Hedge Fund Strategies Flashcards
Hedge Fund Strategy: Equity
Long Short Equity
Market Neutral
Short Biased
Hedge Fund Strategy: Event Driven
Merger Arbitrage
Distress Securities
Highest correlated with the equity market
Hedge Fund Strategy: Relative Value
Fixed Income Arbitrage
Convertible Bond Arbitrage
Hedge Fund Strategy: Oppertunistic
Global Macro
Managed Future
Hedge Fund Strategy: Specialist
- Volatility Strategy
- Reinsurance Strategies
Relative Valuation between two or more securites. Exposed to credit & Liquidity Risk
Hedge Fund Strategy: Muli-Manager
Multi Strategy
Funds of Funds
Characteristics of Equity long-Short
Reliance on Fundamental research
Diverse Investment style.
40-60% Exposure to Net long positions
Gross long exposure 70-90%.
Some managers are able to add alpha by timing the market. Few are successful though.
- Variable Leverage
- High volatility
- Positive beta exposure
- Absolute valuation approach
- Concertrated position size
Leverage levels are negativly related to the level of risk factors exposure the portfolio has.
Characteristics of Short Biased
Dedicated to short only position
60-120% Short position at all times
30-60% net short position
Bottom up approach
Takes short position, then present market research
Attempts to deliver returns that are negativly correlated with the market.
- Low Leverage
- High Volatility
- Negative Beta exposure
- Absolute Valuation approach
- Concentrated positioning sizes
Successful short only fund manager: Increasily positive market returns as the market declines and Risk-free-Rate when the markets increases
Characteristics of Market Neutral
Modest return profile
Aim is to be market neutral
High levels of diversification and liquidity
Purely quantitative managers
Not useful in upward trending markets
- High leverage
- Low volatility
- Beta Exposure is neutral (0)
- Relative Valuation approach
- Diverse Position Sizing.
- Uses relative value approach
- IR = Sharpe Ratio
Market neutral goal is to generate Alpha by reducing Beta.
Characteristics of Merger Arbitrage
Relativly liquid strategy
Moderate to high level of leverage
Soft Catalyst Approach: Trade in the anticipation of an event
Hard Catalyst Approach: Trade in the reaction of an event.
- Typically trades are done using common stock.
- Cash for stock deal: Buy Target Company shares.
- Stock For Stock Deal: Buy target and sell aquirer.
- Relative high Sharpe Ratio
- Low correlation to market return.
- Uncorrelated source of Alpha.
Characteristics of Event Driven: Distress Securities
Return profile investing typically at the high end of event driven strategies with more volatility.
Usually Long biased, subjected to security specific outcomes, still impacted by the health of the macro-economy.
Liquidation: Assets are sold and paid out according to the capital strucutre.
Reorganization: Capital Strucutre Arbitrage, buy securities that would survive. Long Senior Debt, short junior debt or equity.
Moderate or low levels of leverage.
Characteristics of Relative Value: Fixed Income Arbitrage
- Risk/return profile is derived from the high correlation found across different securities.
- High amounts of leverage.
- The more correlated, the lower the risk of the leverage involved.
- Pricing inefficinies are small, but high correlated between securities.
Characteristics of Relative Value: Convetible Bond Arbitrage
- Strive and benefit from strucutally cheap source of implied volatility.
- Embedded options trade at lower volatility levels compared to the underlying asset, making the calls cheap.
- Must accept or hedge away interest rate, credit and market risk.
- High levels of leverage
- works best during times of high convertiblility insurance, moderate volatility, and reasonable market liquidity.
Characteristics of Oppertunistic Strategies: Global Macro
- Wide range of asset classes.
- Focus on theme or regions.
- Top-Down Fundamental approach
- Fiarly hemogenous
- High leverage -6-7 times leverage
- Mean reverting
- mean-reverting low volatility markets offer few oppertunities
- highly liquid
Characteristics of Oppertunistic Strategies: Managed Futures
Uncorrelated with stocks and bonds
Returns tend to be positivly skewed
85-90% of assets are invested in short term government debt.
Time Series Momentum: Trend following. Long assets that are rising in price, and short assets that are dropping.
Cross-sectional Momentum: Same as TSM but a group of large positions against a group of short positions.
highly liquid
Characteristics of Specialist Strategies: Volatility Trading
Long volatility position exhibits positive convexity, which can be useful for hedging strategies.
Relative value volatility arbitrage (buy cheap volatility, and sell more expensive volatility).
Long short VIX futures, Options, or swaps.
Characteristics of Specialist Strategies: Reinsurance/Life Settlement
Insurance company has to much risk exposure for a specific event and at a geographical areas.
Sells a bit of the risk to a reinsurance.
uncorrelated with other assets classes.
Life settlement: Policy holder surrender their policy by selling it to a fund.
Characteristics of Specialist Strategies: Multi-Manager Strategies
Designed to offer steady low-volatility returns via strategy diversification.
Mullti-Manager have outperfomed Funds of Funds.
Multi-Strategie offers potentially faster tatical asset allocation and improved fee strucutre.
Funds of Funds offer potentially offer more diverse strategy mix, and slower tatical reaction time.
Mulit-Strategy uses more leverage than Funds of Funds.
What is a Hard - Catalyst event driven hedge fund investing
Investment made in reaction to an already announced event.
What is a Soft - Catalyst event driven hedge fund investing
Investment made in anticipation of an event
How can we achieve negative correlated returns to a traditional long equity portfolio.
Long volatility
Equity Volatility is approximately 80% negativly correlated with equity market returns.
How will the shares of the Target and Aquirerer companies perform if a deal goes through?
Aquier shares decreases
Target Increases
How will the shares of the Target and Aquirerer companies perform if a deal fails to goes through?
Aquier shares increases
Target Decreases
Which measurement should we use when assessing a portfolio to maximize the risk-adjusted return, considering the expectation of large negative events?
For hedge fund strategies with large negative events, the Sortino ratio is a more appropriate measure of risk-adjusted return than the Sharpe ratio.
The Sharpe ratio measures risk-adjusted performance, where risk is defined as standard deviation, so it penalizes both upside and downside variability.
The Sortino ratio measures risk-adjusted performance, where risk is defined as downside deviation, so it penalizes only downside variability below a minimum target return.
