Hedge Fund Strategies
There are various hedge fund strategies and sub-strategies that exist within the hedge fund universe. It is difficult to explain every single category; there four broad approaches that are commonly used by hedge funds.
Four types of hedge fund strategies
- Relative Value Arbitrate
- Equity-Based; and
- Global Macro
Relative Value Arbitrage
Relative value arbitrage strategy used to take advantage of price discrepancies between financial instruments. When there is the momentary discrepancy in the pricing between two or more related securities, the fund managers try to get benefit from purchasing the security that is expected to appreciate and selling those securities that are depreciating. The transactions will occur simultaneously as the manager behave on the basis of the assumption that the prices of these stock will normalize, arbitrage strategy of hedge funds capitalizing relationship on a relation between the two or more securities in term price. Quick directional movements in the market can be dangerous. Funds managers are not paying attention to individual securities, but also the bucket of securities.
This hedge fund strategy is also known as long/short. It is the most commonly used strategy in the hedge fund by funds managers. The fund manager tells the difference in the stock price by purchasing those securities that are deemed to be undervalued (long) and selling those securities those prices are overvalued (short) at a certain point in time. In this process, the manager uses two types of analyses to identify the fair price of stock-quantitative and qualitative analyses.
For example, fundamental analysis is used to assess the intrinsic value of an investment. While the long/short strategy doesn’t provide fully guarantee protection from the market, an equity market neutral strategy, which uses the same strategy as long/short, minimizes broad market exposure.
This is a hedge fund strategy concern with the situation in which investment opportunity and risk are associated with an event. The company events are further categorized into three parts: – distressed securities, risk arbitrage, and special situations. Distressed securities include such events as recapitalizations, restructurings, and bankruptcies.
Risk arbitrage includes such events as mergers, acquisitions, liquidations, and hostile takeovers. The investors would purchase and sell the share of two or more merger companies to take advantage of market discrepancies. Special situation events are those events that impact the value of the stock of the company. To take the advantages of special events the investor must identify upcoming events that will increase or decrease the value of shares.
This is a hedge fund strategy used by funds managers to analysis the macroeconomics events to identify opportunities for the purpose of investment that would profit from anticipated price movements. Global macro strategy divided into two approaches- discretional approach and systematic approach. The discretional trading approach is carried out by the investment managers who identify and select investment opportunities.
A systematic approach is based on mathematical models. Global macro strategies further divided into subcategories- systematic diversified or systematic currency. Under systematic diversified category, the investors’ trade funds in the diversified market and in systematic currency approach funds trade in the currency market.