Hedge Fund Strategies

Question 1

Hedge Fund Strategy: Equity

Answer 1

Long Short Equity
Market Neutral
Short Biased

Question 2

Hedge Fund Strategy: Event Driven

Answer 2

Merger Arbitrage
Distress Securities

Highest correlated with the equity market

Question 3

Hedge Fund Strategy: Relative Value

Answer 3

Fixed Income Arbitrage
Convertible Bond Arbitrage

Question 4

Hedge Fund Strategy: Oppertunistic

Answer 4

Global Macro
Managed Future

Question 5

Hedge Fund Strategy: Specialist

Answer 5

• Volatility Strategy
• Reinsurance Strategies

Relative Valuation between two or more securites. Exposed to credit & Liquidity Risk

Question 6

Hedge Fund Strategy: Muli-Manager

Answer 6

Multi Strategy
Funds of Funds

Question 7

Characteristics of Equity long-Short

Answer 7

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.

Question 8

Characteristics of Short Biased

Answer 8

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

Question 9

Characteristics of Market Neutral

Answer 9

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.

Question 10

Characteristics of Merger Arbitrage

Answer 10

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.

Question 11

Characteristics of Event Driven: Distress Securities

Answer 11

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.

Question 12

Characteristics of Relative Value: Fixed Income Arbitrage

Answer 12

• 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.

Question 13

Characteristics of Relative Value: Convetible Bond Arbitrage

Answer 13

• 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.

Question 14

Characteristics of Oppertunistic Strategies: Global Macro

Answer 14

• 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

Question 15

Characteristics of Oppertunistic Strategies: Managed Futures

Answer 15

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

Question 16

Characteristics of Specialist Strategies: Volatility Trading

Answer 16

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.

Question 17

Characteristics of Specialist Strategies: Reinsurance/Life Settlement

Answer 17

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.

Question 18

Characteristics of Specialist Strategies: Multi-Manager Strategies

Answer 18

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.

Question 19

What is a Hard - Catalyst event driven hedge fund investing

Answer 19

Investment made in reaction to an already announced event.

Question 20

What is a Soft - Catalyst event driven hedge fund investing

Answer 20

Investment made in anticipation of an event

Question 21

How can we achieve negative correlated returns to a traditional long equity portfolio.

Answer 21

Long volatility

Equity Volatility is approximately 80% negativly correlated with equity market returns.

Question 22

How will the shares of the Target and Aquirerer companies perform if a deal goes through?

Answer 22

Aquier shares decreases
Target Increases

Question 23

How will the shares of the Target and Aquirerer companies perform if a deal fails to goes through?

Answer 23

Aquier shares increases
Target Decreases

Question 24

Which measurement should we use when assessing a portfolio to maximize the risk-adjusted return, considering the expectation of large negative events?

Answer 24

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.