Understanding Hedge Fund Investment Strategies
Despite the portrait the media may paint, all hedge funds are not the same. In fact, every hedge fund has its own secret sauce which defines its goals, strategy, and risk tolerance. Though this seems like common sense, it is easy to fall into the trap of false assumptions when you don’t have access to information allowing you to think otherwise.
In this article, we will give you the unbiased insight you need, providing summaries of the most common strategies amongst hedge funds. This will open your eyes to the different methods used to generate profit in the hedge fund world, and will create a fundamental understanding that will be easy to build upon.
Below, we have listed a few of the most popular strategies associated with today’s hedge fund market. These range from conservative to aggressive, and are mostly implemented in the equities, futures and forex markets. Scroll down and take a look!
Hedge Fund Investment Strategies
Aggressive Growth Hedge Funds: If a hedge fund trades in equities aggressively, they will usually invest in small or micro cap stocks which are expected to experience rapid growth over a short period of time. This includes stocks in sectors such as technology, banking, pharmaceuticals, and biotechnology. For example, a hedge fund manager may short an equity index when earnings reports are expected to be very poor. If an aggressive hedge fund is trading in forex or futures, they will use high leverage lots and “swing trade”, setting their profit goals before even entering into the trade.
Short Selling Hedge Funds: Equity-based hedge funds which “short the market” sell securities in anticipation of being able to re-buy them in the future at a lower price. This can be selling a financial index, large cap stock, or any other tradable equity. Generally, short sale hedge funds will focus on capitalizing in “overbought” markets which are expected to decline. If a short sale hedge fund is trading in futures or forex, they will use the same analysis strategies, but will implement their short positions with varying leverage.
Multi-Strategy Hedge Funds: With this type of hedge fund, the investment approach is diversified by employing various strategies simultaneously to realize short and long-term gains. For example, a hedge fund manager may use a short sale strategy to take advantage of a short-term falling market, and then buy call options to protect and profit from a rising market in the long-term. This style of investing allows the manager to enjoy the benefits of different strategies, and capitalize on far more opportunities in the markets.
Event Driven Hedge Funds: The hedge funds that are considered “event driven” focus on profiting in markets with important news releases or other events. In the equity markets, this can be IPO’s, sudden price changes caused by earnings disappointments, hostile bids, and other global events that affect the markets. If the hedge fund is trading in the forex or futures markets, and is prepared for big events, they can use high leverage and earn a month’s profits in just a few hours.
Option Trading Hedge Funds: The few hedge fund managers that trade options work in the equity or futures markets. By purchasing or selling options, hedge funds can define their risk and reward easier, and produce more stable yields than those with naked positions. For example, a futures trader would implement a “butterfly call spread”, by purchasing 5 Crude “72” options, selling 10 “74’s”, and buying 5 more “76’s”. Though option trading hasn’t been as popular as other hedge fund strategies, it is now becoming utilized by more hedge fund managers than ever.
Hedge Fund of Funds: In recent years, the term “fund of funds” has become very common amongst those in the investment world. By definition, this is a hedge fund which allocates the money of their investors to several other funds with different strategies. By nature, this blending of different strategies and asset classes aims to provide a more stable long-term yield than any individual fund would. This is used by hedge funds that trade in the equities, futures, and forex markets.
As you can see, though you may have two different entities that are considered to be “hedge funds”, they can be as different as night and day. You can have one fund manager who trades options on futures, and another that shorts securities to profit. Despite the focus of this article, you should always understand, it isn’t the strategy that defines your success, it is the experience of the hedge fund manager.
In summary, a “hedge fund” is nothing more than a legal corporate structure, and though each fund may desire profit, their means to attaining it is almost always unique. Remember, false assumptions only hurt the one who assumes, and if you’re smart, you will treat each hedge fund as its own beast. By doing so, you will have a clearer head when making decisions, and a far better chance of succeeding in the hedge fund world.
InsideTrade LLC Staff
Phone: (949) 444-2111