There are many ways of classifying the investment strategies of hedge fund managers. Moreover, among the following strategies, some managers can combine several of them in what are often referred to as “multi-strategy funds”.
Relative value is an investment strategy that aims to exploit pricing inefficiencies between related financial instruments such as stocks or bonds. Relative value managers will value the fundamentals of related nstruments and go long and/or short expecting prices to converge towards a norm. As managers profit from the convergence of relatively small differentials, this strategy can be leveraged in order to enhance returns.
Volatility arbitrage Volatility arbitrage trades the implied volatility versus the historical volatility on the same asset across different strike prices or maturities expecting an increase in the fluctuations of the underlying security’s price.
Statistical arbitrage Managers using this strategy seek to profit from pricing inefficiencies identified using mathematical models. Statistical arbitrage strategies are based on the premise that prices will return to their historical norms.
This strategy seeks to exploit mispricings developed between related classes of fixed income securities such as yield curve and credit spread trading, often neutralising exposure to interest rate risk.
Credit arbitrage Credit arbitrage seeks to take advantage of pricing inefficiencies between the credit sensitive securities of different issuers. Instruments commonly traded include CDOs (collateralised debt obligations) and CDSs (credit default swaps).
Capital structure arbitrage Capital structure arbitrage aims to profit from the pricing inefficiencies across the issuing firm's capital structure with the expectation that the pricing disparity between the two securities will converge.
Convertible arbitrage This strategy captures inefficiencies in the pricing of convertible securities relative to its underlying stocks. Typically, a manager goes long the convertible bond and shorts its common stock, effectively hedging the equity risk. Credit default swaps then allow the credit exposure to be hedged.
This style accounts for the majority of the strategies used by hedge fund managers today. This directional strategy combines both long and short positions in stocks with a simple objective to minimize exposure to the market. A manager would typically short an overvalued stock and go long an undervalued stock. A manager can either be a generalist or focused on specific regions, sectors, industries or market capitalizations. They can also specialize in types of stocks such as value and growth.
Market neutral Market neutral managers seek to exploit investment opportunities unique to some specific group of stocks while maintaining a neutral exposure to broad groups of stocks defined for example by sector, industry, market capitalization, country or region. These portfolios minimise market risk by being simultaneously long and short, and produce one single source of returns (the rule of one alpha).
Short sellers Short selling seeks to profit from declines in the value of stocks. The strategy consists in borrowing a stock and selling it on the market with the intention of buying it back later at a lower price. By selling the stock short, the seller receives interest on the cash proceeds resulting from the sale. If the stock advances, the short seller takes a loss when buying it back to pay back the lender.
This investment strategy generally consists of buying securities of companies in bankruptcy proceedings and/or in the process of restructuring the debt portion of their balance sheets. The complexity of such operations often creates mis-pricing opportunities and hence a potential to profit when prices converge.
Event-driven strategies seek to exploit relative mis-pricings between securities whose issuers are involved in mergers, divestures, restructurings or other corporate events. The strategies can be leveraged to enhance returns.
Merger arbitrage Also known as risk arbitrage, this strategy invests in merger situations. The classic merger arbitrage strategy consists in buying the stock of the target company while simultaneously selling short the stock of the acquiring company.
Special situations Also known as corporate life cycle, this strategy focuses on opportunities created by significant transactional events, such as division spin-offs, mergers, acquisitions, bankruptcies, reorganisations, share buybacks and management changes.
Global macro managers make in-depth analyses of macroeconomic trends in order to arrive at their investment strategy, taking positions on the fixed-income, currency and equity markets through either direct investments or futures and other derivative products.
CTA stands for Commodity Trading Advisor and is also known as a Managed Futures strategy. This strategy essentially invests in futures contracts on financial, commodity and currency markets around the world. Trading decisions are often based on proprietary quantitative models and technical analysis.
Emerging markets' trading strategies include global macro and CTA managers who rapidly adjusts the risk profile of a portfolio to short term market conditions, regardless of long term convictions, with a bias on emerging markets. Such tactical moves can be made either judgementally or with a systematic approach, and may be based on a wide range of data, from economic fundamentals to pure technical indicators.
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