HedgeFundSt r at egi es
Despite years of criticism and negative publicity, Hedge funds have ha ve evolved as higher return generating machines. Thanks to all those amazingly weird Hedge Funds strategies. strategies. If you try to look at the overall picture, you will nd that Hedge funds have now no w become a part of !all "treet#s eco$system. Hedge funds strategies and hedge Funds in themselves have made headlines over the years due to various various reasons. %ou will be awe struck when you you nd out what kinds of perks are given by some hedge Fund Firms Firms to their &nalysts'(anagers.
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Robertson would )y his analysts Former Former hedge fund (anager, Julian Robertson for hiking and camping trips to the !est as part of a team$building e*ercise.
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Te*an Te*an hedge fund manager Kyle Bass takes his whole investment team for spear shing for a week in the +aha +ahamas, mas, every year. year.
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Paul Tudor Jones orders his traders fried chicken on Fridays Fridays on a good week. +ut if they have a down week, they get sushi.
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+lackstone, a hedge fund rm, has an in$house shoe shine person.
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Ray Dalio’s +ridgewater &ssociates has a lu*ury bus that picks up its analysts in the city every morning. morning. The bus has an individual T on the back of every seat along with drinks and snacks onboard.
"o if you want to en-oy such perks, you have to be //0 amazing at your -ob.
And what’s the answer to be an Amazing Hedge Fund Analyst/anager! %our %our ability to properly properly apply Hedge Funds Funds "trategies to get those handsome returns for your investors. In this article, we will be covering the common Hedge Fund "trategies that make these funds successful
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" # $ong/%hort &'uity %trategy
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" ( ar)et *eutral %trategy
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" + erg erger er Arbi Arbitrag trage e %tra %trategy tegy
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" , -on -on.ert .ertible ible Arbitrage Arbitrag e %tra %trategy tegy
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" -a0ital %tru1ture Arbitrage %trategy %tr ategy
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" 2 Fi3ed45n1o Fi3ed45n1ome me Arbitrage %trategy
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" 6 &.en &.entt Dri. Dri.en en %trategy %trate gy
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" 7 8lob 8lobal al a1ro %trategy %trate gy
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" 9 %ho %hort rt :nly %trategy %trateg y
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To0 Hedge Funds in (;#,
The a
" # $ong/%hort &'uity %trategy
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In this type of Hedge Fund "trategy, Investment manager maintains long and short positions in e1uity and e1uity derivative securities.
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Thus, the fund manager will purchase purchase the stocks that they feels is is undervalued and "ell those which are overvalued.
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!ide varieties of techni1ues are employed to arrive at an investment decision. It includes both 1uantitative and fundamental techni1ues.
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"uch a hedge fund strategy can be broadly diversied or narrowly focused on specic sectors.
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It can range broadly in terms of e*posure, e*posure, leverage, holding period, concentrations of market capitalization and valuations.
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+asically, the fund goes long and short in two competing companies in the same industry.
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+ut most managers do not hedge their entire long market market value with short positions.
&3am0le o= $ong/%hort &'uity •
If Tata (otors looks cheap relative to Hyundai, a trader might buy 2//,/// worth of Tata (otors and short an e1ual value of Hyundai shares. The net market e*posure is zero in such case.
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+ut if Tata (otors does outperform Hyundai, the investor will make money no matter what happens to the overall market.
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"uppose Hyundai rises 3/0 and Tata Tata (otors rises 3405 the trader sells Tata Tata (otors for 234,///, 234,///, covers the Hyundai short short for 23/,/// and pockets 24,///.
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If Hyundai falls 6/0 and Tata (otors falls 360, he sells Tata (otors for 244,///, covers the Hyundai short for f or 24/,///, and still pockets 24,///.
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If the trader is wrong and Hyundai outperforms Tata (otors, however, he will lose money.
" ( ar)et *eutral %trategy
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+y contrast, in market$neutral market$neutral strategy, hedge funds target zero net$ market e*posure e*posure which means that shorts and longs have e1ual market market value.
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In such a case the managers generate their entire return return from stock selection.
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This strategy has a lower risk risk than the rst strategy that we discussed, discussed, but at the same time the e*pected returns are also lower.
&3am0le o= ar)et *eutral %trategy •
& fund manager may go long in the / biotech stocks that are e*pected to outperform and short the / biotech stocks that may underperform.
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Therefore, Therefore, in such a case the gains and losses will o7set o7set each other inspite how the actual market does.
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"o even if the sector moves in any direction the gain on the long stock is o7set by a loss on the short.
" + erger Arbitrage %trategy •
In such a hedge fund strategy the stocks of two merging companies are simultaneously bought and sold to create a riskless prot.
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This particular hedge fund strategy looks looks at the risk that the merger merger deal will not close on time, or at all.
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+ecause of this small uncertainty, this is what happens8 The target company#s company#s stock will sell at a discount to the price price that the combined entity will have, when the merger is done.
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This di7erence is is the arbitrageur#s prot. prot.
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The merger arbitrageurs arbitrageurs care only only about the probability of of the deal being approved and the time it will take to close the deal.
&3am0le o= ar)et Arbitrage %trategy 9onsider these two companies: &+9 9o. and ;%< 9o. 9 o.
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"uppose &+9 9o is trading at 23/ per share when ;%< 9o. comes along and bids 26/ per share which is a 3=0 premium.
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The stock of &+9 will -ump -ump up, but will soon settle at some price price which is higher than 23/ and less than 26/ until the takeover deal is closed.
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>et#s say that the deal is e*pected to close at 26/ and &+9 stock is trading at 234.
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To To seize this price$gap opportunity, opportunity, a risk arbitrageur would purchase purchase &+9 at 23?, pay a commission, hold on to the shares, s hares, and eventually sell them for the agreed 26/ ac1uisition price once the merger is closed.
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Thus the arbitrageur makes makes a prot of 23 per share, or a @0 gain, less the trading fees.
" , -on.ertible Arbitrage •
9onvertibles generally are the hybrid securities including a combination of a bond with an e1uity option.
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& convertible arbitrage hedge fund typically includes long convertible bonds and short a proportion of the shares into which they convert.
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In simple terms it includes a long position on bonds and short position on common stock or shares. sha res.
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It attempts to e*ploit prots when there is a pricing error made in the conversion factor i.e. it aims to capitalize on mispricing between a convertible bond and its underlying stock.
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If the convertible bond is cheap or if it is undervalued relative to the underlying stock, the arbitrageur will take a long position in the convertible bond and a short position in the stock.
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An the other hand, if the convertible bond is overpriced relative relative to the underlying stock, the arbitrageur will take a short position in the convertible bond and a long position in the underlying stock.
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In such a strategy managers try to maintain a delta$neutral position so that the bond and stock positions o7set each other as the market )uctuates.
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BDelta *eutral Position4 "trategy or Cosition due to which the value of the Cortfolio remains unchanged when small changes occur in the value of the underlying security.
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9onvertible arbitrage generally thrives on volatility. The reason for the same is that, more the shares shares bounce, more the the opportunities arise to ad-ust the delta$neutral hedge and book trading prots.
&3am0le o= -on.ertible Arbitrage %trategy •
isions 9o. decides to issue a $year bond that has a =0 coupon rate. "o on the rst day of trading it has a par value of 2,/// and if you held it to maturity B year you will have collected 2=/ of interest.
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The bond is convertible to =/ shares shares of ision#s ision#s common shares whenever the bondholder desires to get them converted. The stock price at that time was 23/.
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If ision#s stock price rises to 23= then the convertible bondholder could e*ercise their conversion privilege. They can now receive =/ shares of ision#s stock.
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=/ shares at 23= is worth 23=/. "o if the convertible bondholder bought the bond at issue B2///, they have now made the prot of 23=/. If instead they decide that they want to sell the bond, they could command 23=/ for the bond.
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+ut what if the stock price drops to 2=E The conversion comes to 24=/ B2= =/. If this happens you could simply never e*ercise your right to convert to common shares. %ou %ou can then collect the coupon payments and your original principal at maturity.
" -a0ital %tru1ture Arbitrage •
It is a strategy in which a rm#s undervalued security is bought and its overvalued security is sold.
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Its ob-ective is to prot from the pricing ineGciency in the issuing rm#s capital structure. structure.
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It is a strategy used by many directional, 1uantitative and market neutral credit hedge funds.
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It includes going long in one security in a company#s capital structure while at the same time going short in another security in that same company#s capital structur s tructure. e.
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For e*ample, e*ample, long the sub$ordinate s ub$ordinate bonds and short the senior bonds, or long e1uity and short 9D".
&3am0le o= -a0ital %tru1ture Arbitrage &n e*ample could be : & news of particular company performing badly. In such a case, both its bond bon d and stock prices are likely likely to fall heavily. heavily. +ut the stock price will fall by a greater degree for several reasons like8
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"tockholders are at a greater risk of losing out if the company is li1uidated because of the priority claim of the bondholders
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Dividends are likely to be reduced. The market for stocks is usually more li1uid as it reacts to news news more dramatically.
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!hereas on the other hand annual bond payments are *ed.
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&n intelligent fund manager will take advantage of the fact that the stocks will become comparatively much cheaper than the bonds.
" 2 Fi3ed45n1ome Arbitrage •
This particular Hedge fund strategy makes prot prot from arbitrage arbitrage opportunities in interest rate securities.
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Here opposing positions are assumed in the market to take advantage of small price inconsistencies, limiting interest rate risk. The most common type of *ed$income *ed$income arbitrage is swap$spread arbitrage.
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In swap$spread arbitrage opposing long and short positions are taken in a swap and a Treasury bond.
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Coint to note is that such strategies provide relatively relatively small returns and can cause huge losses sometimes.
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Hence this particular Hedge Fund strategy is referred referred to as ?Pi1)ing
u0 ni1)els in =ront o= a steamroller@’ steamroller@’ &3am0le o= Fi3ed 5n1ome Arbitrage A Hedge =und has ta)en the =ollowing 0osition> 0osition> $ong #;;; (4year uni1i0al Bonds at (;;C •
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,/// * 23// 23//,/// of risk Bunhedged The (unicipal bonds payout 0 annually interest interest rate : or 60 60 semi. Duration is 3 years, so you receive the principal after 3 years.
&fter &fter your rst year, the amount that you have made assuming that you choose to reinvest the interest in a di7erent asset will be8
(;;;;; 3 C;2 #(;;; &fter 3 years, you will have made 23///3 23@,///. +ut you are at risk the entire time of8
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The municipal bond not being paid back. Jot receiving your interest.
"o you want to hedge this duration risk The Hedge Fund Fund (anager "horts Interest Interest Kate "waps for two companies companies that pays out 0 annual interest rate B60 semi$annually and is ta*ed at =0. 23//,/// * ./ 23,/// * B/.L= 2,@// "o for 3 years it will be8 2,@// * 3 33,?// Jow if this is what the (anager pays out, then we must subtract this from the interest made on the (unicipal +ond8 23@,///$233,?// 2,3//
Thus 23// is the prot prot made.
" 6 &.ent Dri.en •
In such a strategy the investment (anagers maintain positions in companies that are involved in mergers, mergers, restructuring, tender o7ers, shareholder buybacks, debt e*changes, security issuance or other capital structure ad-ustments.
&3am0le o= &.ent Dri.e %trategy Ane e*ample of Mvent driven strategy is distressed securities. In this type of strategy, the hedge funds buy the debt of companies that are in nancial distress or have already led for bankruptcy. If the company has yet not led for bankruptcy, the manager may sell short e1uity, betting the shares will fall when it does le.
" 7 8lobal a1ro •
This hedge fund strategy aims to make make prot from from large economic economic and political changes in various countries by focusing in bets on interest rates, sovereign bonds and currencies. currencies.
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Investment managers analyze the economic variables and what impact they will have on the markets. +ased on that they develop investment strategies.
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The (anagers analyze how macroeconomic macroeconomic trends trends will a7ect interest interest rates, currencies, currencies, commodities or e1uities around the world and take positions in the asset class that is most sensitive in their views.
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ariety of techni1ues like systematic analysis, 1uantitative and fundamental approaches, long and short$term holding periods are applied in such case.
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(anagers usually prefer highly li1uid instruments like futures and
currency forwards for implementing this strategy. Examp mpl eofGl obalMacr oSt r at egy &n e*cellent e*ample e*ample of a Nlobal (acro "trategy is Neorge "oros shorting of the pound sterling in LL3. He then took a huge short position of over 2/ billion worth of pounds. He conse1uently made a prot from the +ank of Mngland#s reluctance to either raise its interest rates to levels comparable to those of other Muropean M*change Kate (echanism countries or to )oat the currency. "oros made . billion on this particular pa rticular trade.
" 9 %hort :nly •
"hort selling is an investment strategy which includes selling the shares that are anticipated to fall in value.
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In order to successfully implement this strategy, the fund managers have to scour the nancial statements, talk to the suppliers or competitors to dig any a ny signs of trouble for that particular company. company.
To0 Hedge Funds o= (;#, +elow are the Top Hedge Funds of 3/@ with their respective hedge fund strategies$
source8 Pre'uin &lso, note the the hedge funds "trategy distribution of the Top Top 3/ hedge funds compiled by Cre1uin Cre1uin
source8 Pre'uin •
9learly, Top hedge funds follow M1uity "trategy with 4=0 of the Top 3/ funds following the same.
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Kelative alue strategy is followed by /0 of the Top 3/ Hedge Funds
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(acro "trategy, Mvent Driven and (ulti$"trategy makes makes the remaining =0 of the strategy
-on1lusion Hedge Funds do generate some amazing compounded annual returns. However, these returns depend on your ability to properly apply Hedge Funds "trategies to get those handsome returns for your investors. !hile ma-ority of the hedge funds apply M1uity "trategy, others follow Kelative alue, (acro "trategy, Mvent Driven etc. %ou can also master these hedge fund strategies by tracking the markets, investing and learning continuously. continuously.
