A hedge fund is an alternative investment that uses pooled funds and employs different strategies for improving the active returns for its investors. Hedge funds can be aggressively managed and may even use leverage or derivatives in both international and domestic markets for creating high returns.
However, managing hedge funds is easier said than done; for that purpose, you—the investor—should employ different strategies. That is why, in this write, we are giving you an overview on different strategies that every leading lending platform may use for managing hedge-fund portfolios. So let us get down to the details.
Equity market neutral
These funds are designed to identify undervalued or overvalued equity securities. In this strategy, a portfolio’s exposure to market risk is neutralized by bringing together short and long positions; by setting the portfolio beta around zero, such a portfolio is generally structured to be dollar, industry, sector, and market neutral. Such neutrality can be achieved by holding short and long equity positions with equal exposure to the related sector or market factors. In this strategy, the benchmark is set at a risk-free rate because the style aims for an absolute return.
Convertible arbitrage
This strategy aims to use mispricings in all the corporate convertible securities including warrants, convertible preferred stock, and convertible bonds. In this category, the managers sell or buy such securities; afterward, a part or all of the associated risks are hedged. A simple example of this strategy is purchasing convertible bonds, and then hedging just the equity component of their risk by shorting the associated stock. This strategy will simply make money if an underlying asset’s price increases or if its volatility increases because of the embedded option. On the type of hedging done, the strategy will let you make more money if an issuer’s credit quality improves.
Fixed-income arbitrage
Like the equity market neutral, this strategy will let the funds try identifying undervalued or overvalued fixed-income securities; this identification will be chiefly done as per the expectations of changes that may happen in the credit quality or the term structure of the market sectors. The hedge fund portfolios, which are based on this strategy, are nearly neutralized against any directional market movements as they combine short and long positions. Because of that reason, the portfolio’s duration is very close to zero.
Distressed securities
The portfolios of all the distressed securities are almost always invested in the equity and debt of only those companies that are nearing bankruptcy or that have gone belly-up. Many investors are neither prepared for facing any legal difficulties nor game for negotiations with different claimants and creditors. All the traditional investors prefer transferring such risks to other fellow speculators when a business is likely to default. Also, most investors are generally prohibited from holding those securities that can default or are in default.
Merger arbitrage
Also known as deal arbitrage, this strategy plans to capture the price spread between a corporate security’s current market price and its value after a takeover, spin-off, merger, etc. In this strategy, the opportunity generally involves purchasing the stock of any target company right after a merger is announced and even shorting some stocks belonging to the acquiring company.
Hedged equity
Also referred to as the long/short equity strategy, this one tries picking the undervalued and overvalued equity securities. The portfolios built using this strategy are generally not structured to remain dollar, sector, market, and industry neutral; instead, they can be highly concentrated. For instance, the total value of all the short positions may just be a small part of the total value obtained from long positions; plus, in this case, the portfolio can have net long exposure to the existing market equity. Hedge equity is regarded as one of the biggest hedge-funding strategies when it comes to analyzing the assets that are under management.
Global macro
These strategies try leveraging all the systematic moves that are common in many non-financial and financial markets; such moves generally include trading in futures, option contracts, and currencies. In general, this strategy differs from all the traditional hedge-funding strategies. Most global macro managers rely on derivatives, such as options and futures, in their existing strategies. Also, managed futures may sometimes be categorized under the global macro option.
So these are the most common strategies that could be used for managing the portfolios having hedge funds. If you have already managed hedge-fund portfolios and have some other innovative strategies to do the management work, then drop your thoughts below.
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