What is a Hedge Fund?
Hedge Funds are private capital reserves for investment with the flexibility to buy or sell a wide range of assets. It is basically a name for an investment company. The purpose of a hedge fund is to maximize investor returns and reduce risk, hence the word ‘hedge’. It aims to benefit from market failures rather than relying purely on economic growth for performance. These funds are very illiquid, in particular by limitations on redemption and ceilings for withdrawal.
Key strategies of hedge funds
There is no universal formula, and the types of investment strategies pursued by individual Hedge Funds are extremely diverse.
These funds are characterized by the large margins of maneuver they have in their investment policies such as the combination of long and short positions or the massive use of leverage. Together, Hedge Funds are capital reserves for investment with the flexibility to employ a wide range of trading strategies in both traditional and non-traditional markets. They use multiple stocks (stocks, currency bonds, commodities, unlisted securities, real estate, etc.) as well as derivatives (options and exotic options, futures swaps, etc.)
This includes all directional strategies of taking positions in line with market trends, and based on macroeconomic expectations such as GDP growth, interest rates, exchange rates or commodity prices First. For example, if the manager anticipates a decline in US GDP and an increase in world oil production, it may speculate on the decline in this asset.
This strategy, which is the most widely used in hedge funds, involves taking buy positions on undervalued securities and selling positions on overvalued securities. The manager seeks to arbitrate market anomalies and can gain in downward trend as well as in bullish trend.
Moreover, this strategy makes it possible to benefit from a double leverage effect (double alpha effect). Long-short equity strategies may be directional or ‘biased’ depending on the proportion of long position versus short positions in the fund. So a small amount can be dedicated short if it consists of only short positions or long biased if the amount of long positions exceeds that of short ones.
A fund may also not be directional but ‘market neutral’ i.e. the amount of its short sales covers the amount of its long positions, which involves constantly switching back the asset proportions long and short to adapt to fluctuations. This type of long-short equity strategy is adapted in case of high market volatility.
It is a strategy to arbitrate deformations and movements of the yield curve (comparative analysis of long rates and short rates) through vehicles such as government bonds, interest rate futures or swaps. For example such a strategy may involve acting on a return to the average of a yield curve deviation in the case of an abnormal deformation of the curve.
Convertible Bond Arbitrage
This management is usually to take a long position on the convertible bond and short on the underlying share, while eliminating the interest rate risk related to the requirement for a swap. Convertibles are usually selected using complex modeling tools that will detect an arbitrage opportunity. Since the gain is relatively low on each arbitrage, the managers use an important leverage effect.
This type of fund specializes in investing in emerging markets. This strategy generally presents a considerable risk as the underlying indices and stocks are generally very volatile in view of the large country risk and the hedging instruments are traditionally not very developed in the emerging countries.
This type of strategy generally relies on algorithms to take speculative positions, short or long contracts on futures of any type of commodities, indices, etc. These strategies are generally based on the type of technical analysis (trend following) where the hedge fund manager will analyze selling or buying signals (example moving averages) to systematize the trading system that will then manage the fund quasi-autonomously by following the signals.
These are various strategies that involve taking positions in securities to take advantage of pricing inefficiencies in special situations such as mergers and acquisitions (known as merger arbitrage) or restructuring debts of bankrupt companies. An example can be the manager speculating on the difference between the price announced by the acquirer at a takeover bid and the actual price at which the transaction takes place on the market.