Hedge Fund Strategies
Date Added: July 19th,
2004
By Chris Stallman
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While
we find it highly unlikely that our readers will be investing in
hedge funds anytime soon (after all, the minimum investment is usually
$250,000), they're still interesting things to learn about.
Like mutual
funds, there are a variety of different hedge fund classifications.
Each fund has its own strategy that it uses to try and earn a high
return on investment for its investors. Each of these strategies
varies in the types of returns they generate and in their expected
volatility, as you are about to see.
Aggressive Growth Volatility:
High
Aggressive growth hedge funds
typically take an aggressive approach to investing by buying stocks
with high P/E multiples and shorting stocks that are likely to miss
their earnings estimates. They're usually biased towards investing
in companies in the technology and biotechnology sectors.
Distressed Securities
Volatility: Moderate
These funds buy equity or
debt in companies that are facing bankruptcy. These fund managers
usually think that the general public doesn't understand troubled
companies very well so they seek to profit from deeply discounted
securities.
Emerging Markets
Volatility: Very High
Emerging market funds invest
in stocks or bonds of emerging markets. These are considered
very volatile because emerging markets typically have higher inflation
and volatile economic conditions. Not all emerging markets allow
short selling so hedging is usually not available.
Income Volatility:
Low
Hedge funds with a focus
on income usually focus on high-yield stocks or bonds. They also
might purchase fixed income derivatives that enhance their profit
from the appreciation and interest income.
Macroeconomic
Volatility: High
Macroeconomic funds aim to
profit from changes in global economies. They are typically involved
in stocks, bonds, commodities, and currencies. These funds
usually use derivatives to increase the impact of market movements.
Market Neutral Volatility:
Low
Market neutral funds attempt
to remove the market risk from their portfolios by being both long
and short in a given sector. A market neutral fund may pick
two similar stocks and purchase the one it feels is better and short
the stock that is weaker, hoping that the stock it likes more outperforms
the other stock.
Opportunistic
Volatility: Depends
These types of hedge funds
often vary their investment strategies to whatever conditions they
feel are profitable at the time. For example, if the IPO market
is hot, they may attempt to buy in on a large number of IPO's.
Or they will be involved in hostile takeovers.
Short Selling
Volatility: Very High
Short selling funds short
all of the investments in their portfolio. These funds often
come into favor when people feel the market is about to approach
a bearish cycle. However, since short selling a stock exposes
the investor to an unlimited amount of risk, these funds are often
seen as very risky.
Special Situations
Volatility: Depends
Special situation hedge funds
invest in event-driven situations such as mergers, hostile takeovers,
bankruptcies, or leveraged buy outs. Many of these funds will
buy stock in the company being acquired and sell or short the stock
in its acquirer. These funds' results usually aren't dependent
on the direction of the overall market.
So as you can see, there are a number of different
strategies hedge funds can use. If you want to read a good
book about how a hedge fund can enjoy amazing success and then squander
it all away, we recommend you check out "When
Genius Failed."
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