Despite hedge funds having a very wide range of investment routes open to them, hedge funds can be classified by their broad investment strategy. Hedge fund mandates are typically very broad, allowing scope for the manager to move between strategies as they deem appropriate. Some of the main investment strategies include long short equity. This is the original hedge fund model and was the strategy Alfred Winslow Jones used in the first hedge fund in 1952. As the name implies, this strategy attempts to make gains from both increases in price and price decreases. This is done by taking long positions in stocks that are believed to be undervalued, earning money if the stock price goes up, and also shorting stocks that are believed to be overvalued to earn money when the price of these stocks drop. Short selling involves borrowing the stock from a current shareholder and selling it in the hope of repurchasing it later at a lower price before returning it to the party that it was borrowed from. Compared to other hedge funds With far more varied investments, the long short equity strategy is relatively straightforward. A classic long short weighting is 130 30, where 130% of the client's money is invested in long positions, and the value of short positions is equivalent to 30% of the client's invested funds short selling generates cash, and this 30% short position provides the cash to hold long positions equivalent to 130% of the client's funds.
Arbitrage based, arbitrage is an investment strategy in which an investor simultaneously buys and sells and assets in different markets to take advantage of price differences and to generate a profit. While price differences are typically small and short-lived, the returns can be impressive when traded in large volumes.
Equity market neutral. This strategy is similar to long short equity in that it invests in equity and uses both long and short positions. The difference is that while the long short strategy can favor a market direction, such as the classic 130 30 approach, a market neutral strategy is designed to be generally neutral to market movements, meaning that the value of long positions broadly equates to the value of short positions, meaning that gains and losses resulting from broad market movements will cancel each other out, and gains for the fund are made by identifying mispriced securities within the market.
Event driven, an event driven strategy refers to an investment strategy, which attempts to profit from stock mispricing that may occur during or after a corporate event, such as a stock splits rights issue, or dividend payout. Generally, funds will have teams of specialists who analyze corporate events from multiple perspectives before recommending action.
Risk arbitrage, risk arbitrage, also known as merger arbitrage, is an investment strategy to profit from the narrowing of the gap between the traded price of a company subject to a takeover bid, and the takeover offer price being made in an intended takeover deal. If a long position is taken, the investment strategy will be profitable if the deal is completed.
Fixed income arbitrage when using a fixed income arbitrage strategy, an investor assumes opposing long and short positions in similar bonds to take advantage of small price discrepancies while limiting interest rate risk. These differences could be in maturity, credit risk, or newly issued versus bonds issued longer ago, referred to as on the run and off the run, respectively.
Convertible bond arbitrage, the underlying asset in the convertible bond arbitrage strategy is not surprisingly a convertible bond. To understand this strategy, it's therefore necessary to know how convertible bonds work. A convertible bond is not a typical bond, but rather it is a bond which can be converted into a fixed number of shares of the company that issued the bond at the choice of the investor. Convertible bond arbitrage involves taking long and short positions on a convertible bond and the stock of the company that issued the convertible bond. The goal of this strategy is to have the right amount of hedging between long and short positions to profit from market movements.
