Topic 5-Alternative Investments ((v) The four main investment strategies of hedge funds)

Question 1

What are the 4 main types of investment strategies of hedge funds?

Answer 1

• Long/short
• Market neutral
• Global macro
• Event driven

Question 2

Hedge Fund Investment Strategy (Long/Short)

Answer 2

• Long/short funds are the traditional type of hedge funds, taking short and long bets in common stocks.

– They vary their short and long exposure according to forecasts, use leverage, and now play on numerous markets throughout the world.

• These funds often maintain net positive or negative market exposures; so they are not necessarily market-neutral.

– A subgroup within this category is funds that have a systematic short bias, known as dedicated-short funds, or short-seller funds

Question 3

Hedge Fund Investment Strategy (Market Neutral)

Answer 3

• Market-neutral funds are a form of long/short funds that attempt to be hedged against a general market movement
• They take bets on valuation differences of individual securities within some market segment.
• Total value of the position held long equals the total value of the short positions.
• Derivatives can be used as an alternative to short positions
• Some techniques used by market-neutral funds are the following:

1. Equity long/short
2. Fixed-income arbitrage
3. Pairs Trading
4. Mortgage Arbitrage etc.

• It must be stressed that these funds are not riskless because hedges can never be perfect.
• Loss can be incurred and it can be high because hedge funds tend to be highly leveraged.

Question 4

Hedge Fund Investment Strategy (Global macro)

Answer 4

• Global macro funds take bets on the direction of a market, a currency, an interest rate, commodity, or any macroeconomic variable
• These funds tend to be highly leveraged and make extensive use of derivatives
• There are many subgroups in this category including

1. futures funds
2. emerging-market funds.
3. Futures funds take bets on directional moves in positions they hold (long and short) in a single asset class such as currency, fixed income of commodities. They tend to use a lot of actively traded futures contracts
4. Emerging Market funds take bets on all types of securities in emerging markets. Emerging market investments tend to be fairly volatile and greatly influenced by economic and political factors.

Question 5

Hedge Fund Investment Strategy (Event driven)

Answer 5

• Event driven funds take on bets on some event specific to a company or a security.
• Typically the events are special situations or opportunities to capitalize on price fluctuations
• These include:

1. Distressed securities funds
2. Risk arbitrage in mergers and acquisitions
3. Distressed securities funds: the manager invests in the debt and or equity of companies having financial difficulty,. Because the companies are in distress, managers can buy company securities at a deeply discount rate and they can make a lot of money if the company successfully reorganizes and does well.
4. Risk arbitrage in M&A - before the date of the merger, the stock of the acquired company will typically sell at a discount to its acquisition value. A hedge fund manager buys stocks in a company being acquired and sells stock in its acquirers.
   - If the takeover falls through, fund managers can be left with large losses