There are hundreds of unique hedge fund strategies and thousands of unique approaches.
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How should you market your hedge fund? Will you employ one strategy or a mix of strategies?
The following are nine commonly known strategies employed by hedge funds. They are ordered from the lowest-expected volatility, to the highest. Expected volatility is a measure of how predictable performance will be (with high volatility being relatively unpredictable, and low volatility being relatively predictable). Leverage could be added or reduced to adjust for volatility with any strategy. When picking a hedge fund strategy, it all depends on your (and your clients') level of risk tolerance.
- Market Neutral - Arbitrage: Hedge against market risk by taking long and short positions in different securities of the same company. For example, shorting a company's equity while going long on the company's bonds. Focuses on relative value instead of absolute value. May invest in fixed income, mortgage backed securities, capital structure, and close-end funds.
- Market Neutral - Securities Hedging: Equal focus on both long and short equity positions in the same sector, reducing market risk. Very low correlation with market performance.
- Income: Focuses on yield or current income rather than growth. May utilize leverage to buy bonds and sometimes fixed income derivatives in order to profit from principal appreciation and interest income.
- Value: Attempt to invest in securities that are below their intrinsic value. Usually invests in firms that are out of favor and selling at a discount. Long-term investment focus.
- Distressed Securities: Buys securities of companies that are in or facing bankruptcy or reorganization. Profits from institutional selling pressure (since most institutional investors could not own below investment grade securities). Performance has little to no correlation with the market.
- Fund of Funds: Invests in other hedge funds. Attempts to control risk and return through diversification in both asset classes and strategies. Very high fee structure with two layers of management and performance fees.
- Aggressive Growth: The opposite of fixed income. Focus on growth instead of yield. Invests in small or micro cap companies. Long-biased positions.
- Emerging Markets: Invests in developing, less mature markets that tend to have both higher inflation and volatility. Since short-selling is not permitted in most emerging markets, market risk is not hedged.
- Macro: Investments based on global variables such as change in government policy, currency fluctuation, market panics, etcetera. Tend to use high leverage.