Hedge Fund Styles
Hedge Fund Introduction
Hedge Fund, are not, as some may claim, alternative investments by
definition. Most of the hedge funds invest in listed (or unlisted)
equities, bonds or other derivatives that are easy to understand on a
stand alone basis. That is highly traditional investments.
Thus, hedge funds are not something fundamentally new
to the seasoned investor, but should be something that can be understood
from the perspective of traditional instruments, sliced and diced
differently from the plain vanilla beta exposure that is received
through bonds and equities in the ‘traditional’ portfolio framework.
Today, hedge funds are a pretty common element in the marketplace, and
is sometimes even sold to retail investors.
Depending on how one views a total return investment, from a market
factor perspective or from a funding perspective, the elusive Alpha is
going to be defined differently. From a market factor perspective, some
hedge fund programs can be mapped down to Beta factors, that is, a
regression against a set of market factors results in good fit. For some
strategies, it is easy to find good and relevant market factors, for
some other it is hard or almost impossible to find the proper factors.
Under each strategy, we will define some relevant market factors and
show examples of how to address beta through traditional investments.
If one view a hedge fund as total return investment, then the
investor should not care if the fund is correlated with bonds or stocks,
only the actual funding cost of the capital used to invest in hedge
funds.
Hedge Fund Styles - Introduction
This section will outline some of the hedge fund classification that
exists today. Given the large number of styles, some present on the
Swedish, Danish, Finnish or Norwegian hedge fund market, some virtually
non-existent. The classification here will be according to the major
index providers.
One way to divide strategies is according to the markets that they
trade. Convertible Arbitrage, Dedicated Short Bias, Emerging Markets,
Event Driven, Fixed Income Arbitrage, Global Macro, Long/Short Equity,
Managed Futures (CTA) and Multi-strategy is one way of classifying
strategies upon markets and to some extent upon the actual strategies.
A hedge fund manager can also be classified into decision making
part, if the process is discretionary or systematic, if the process is
bottom-up or top-down etc.
While a style classification never can be a complete description of a
certain manager it is sometimes a good starting point for further
research. The following pages will try to give the reader some insights
into the world of active management and alpha generation.
Each classification will be illustrated by one or more trade examples
that a certain strategy typically engages into. Please note that this is
not an instruction on how to create your own hedge fund, while you
probably are able to do so, profitable trades are highly unlikely to be
found on any webpage, no matter the quality of it.
Typically, a manager’s style is self pro-claimed and has some
relationship to the fund that is actually managed. Sometimes, the style
has no relationship with the active management of the fund. Therefore,
it is important to compare the manager’s report on what is actually
happening in the fund (with the usual reporting delay) against your
expectations on how the trading should commence.
Managers proclaiming themselves to be equity market neutral that
suddenly reports a significant net long equity exposure for a prolonged
period is most likely not an equity market neutral manager. This is an
example of so called Style Drift and is a classical risk factor,
sometimes it is necessary; in some cases it adds only risks.
Hedge Fund Index – Introduction
In some cases, a group of hedge fund can be grouped, in order to form
a peer group. This is sometimes useful if the investor would like to
measure the performance of one manager against the hedge fund universe.
Nordic Long Short Equity manager would be a group that would largely
share the same investment opportunities. Sometimes, indexes are less
applicable, especially when the peer group is highly homogenous. This is
further explained under the hedge fund index section.