In this article, we will be looking at the hedge fund strategies, features, types and all you need to know. But before we continue, we will first of all explain what a hedge fund is all about. A hedge fund can be defined as an investment fund created by institutional investors and accredited investors with the main aim of maximizing returns and reducing or eliminating risk not minding if the market trend is going up or coming down.
A hedge fund is a private investment partnership that exists between the investors of the fund and the fund manager. This type of relationship could be structured as a limited partnership or limited company. The partnership that exists between the investors and fund managers has little or no regulation from the Securities and Exchange Commission (SEC).
The Main Hedge Fund Strategies
The following are the main hedge fund strategies that you need to know:
Capital Structure Strategies
Most hedge funds take advantage of the wrong prices of securities raising and falling the capital structure of a particular company. For instance, if they believe that the debt is overestimated, they reduce the debt and go long the equity. This situation will create a hedge and be hoping for the eventual spread correction between the securities.
Directional Hedge Fund Strategies
A directional hedge fund strategy is are situation where the managers stake on the directional moves of the market (whether long or short) as they still expect that the market trend will continue the way it is or change within a period. The manager must analyze the market movements, inconsistencies or trends. The manager monitors it and applies it to the vehicles like long or short equity hedge funds and emerging markets funds.
Event-Driven Hedge Fund Strategies
This is used in situations where the underlying opportunity and risk are associated with a particular event. In this type of situation, the fund manager finds investment opportunities in corporate transactions like acquisition, bankruptcy, consolidation, liquidation and recapitalization. These types of transactional events form the foundation for investments in distressed securities, arbitrage and any other special situations
Global Macro Strategies
In this situation, the managers make bets based on the major global macroeconomic trends like changes in interest rates, demographic shifts, economic cycles and currencies. The fund managers use optional and systematic approaches in major financial and non-financial markets by trading on bonds, currencies, futures, traditional equities, and options contracts. One of the most famous examples of a global macro fundis the Bridgewater.
Long/Short Strategies
Long/ short hedge fund strategies are situations where managers use pair trades to bet on two securities in the same industry. For instance, if they expect Fanta to perform better than Mirinda, they would go long Fanta and short Mirinda. Without looking at the overall market trends, the managers will be okay as long as Fanta performs better than Mirinda on a relative basis.
Relative Value Arbitrage Strategies
This type of fund strategy takes advantage of relative price differences between various securities whose prices the managers expect to separate or come together over time. Some of the sub-strategies in this category include convertible arbitrage, equity market neutral positions, fixed income arbitrage volatility arbitrage etc.
Distinct Features Of A Hedge Fund
The following are the distinct features of a hedge fund that you need to know:
- Hedge funds can exist as large investments in various sectors such as commodities, currencies, derivatives, land, stocks etc.
- Hedge fund is open to only accredited and qualified investors. It cannot be offered or sold to the general public. Before you will be considered as a potential investor, certain net worth requirements must be met and it includes having a net worth of more than $1M excluding primary residence.
- In Hedge fund strategies, investors are required to maintain their money in the fund for a fixed period of at least one year. And here, they can only withdraw funds at specific times like semi-annually or quarterly.
- Hedge fund strategies attract management and performance fees. There is also an annual manager’s fee of 1% of the amount of invested assets and performance fees of 20% on gains.
- The funds in hedge funds strategies use different investment strategies that must be disclosed beforehand to the investors.
- The hedge fund uses borrowed money to create leverage and multiply returns.
Types Of Hedge Funds
The following are the types of hedge funds you need to know:
Open-ended Hedge Funds
This is the type of hedge fund where shares are continuously issued to investors and allow for periodic withdrawals of the net assets value of each share.
Closed-Hedge Funds
In this type, only a limited number of shares are issued through an initial offering and they do not issue new shares even if the investor wants an increase in the number of shares they have.
Shares Of Listed Hedge Funds
This is the type that is traded on the stock exchange and non-accredited investors may also purchase the shares.
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Advantages And Disadvantages Of Investing In Hedge Funds
In as much as investing in hedge funds can give an investor high returns, there are also risks associated with high-reward investments. Before deciding to invest in hedge funds, there are some advantages and disadvantages you must know.
Advantages Of Hedge Funds
- Hedge funds use different investment strategies which provide the ability to generate positive returns despite favourable or unfavourable market conditions.
- It gives the investors the ability to precisely customize investment strategies.
- Having a balanced portfolio hedge can decrease the overall risk and volatility with multiple returns on investment.
- It helps investors to access the services of skilled investment managers.
Disadvantages Of Hedge Funds
- When investors use a borrowed fund to hedge, it can turn a minimal loss into a major loss.
- Hedge funds usually require that investors fix their money for years.
- It exposes funds to huge potential losses if the strategy taken is the wrong one.