Hedge Fund Strategies - Essay Example

Hedge Fund Strategies As an aggressive investment vehicle, a hedge fund invests in securities from capital pooled from numerous investors. Since they cater to sophisticated investors and are not sold to retail investors and the general public, hedge funds are largely unregulated, in contrast to mutual funds. However, there are strategies under which hedge funds are managed, and this paper will describe the Global Macro, Long/Short Equity, Fixed Income Relative Value, and Event-Driven strategies. Global Macro These strategies invest in bonds, stocks, and currencies and characteristically have the highest risk and return profiles.

Often placing directional bets on the prices of principal assets, they are highly leveraged and can grow exponentially before facing challenges posed by capacity issues. Macroeconomic analysis is used by managers of global macro funds based on global market trends and events to identify investment opportunities. This is achieved typically by analyzing trends of interest rates, government policies, intergovernmental relations, political changes, and flow of funds, all founded on educated guesses and decision-making about global macroeconomic developments (Stowell 93).

Global macro traders are fundamentally on the risk side of the business since the risk is their primary decision-making element. The reason behind this is that the moving data points and risk factors to be considered in order to invest in the speculative world are so many. Global macro strategies are expected to perform best in the bond market at the point of the cycle when short-term rates remain low and not increasing, unlike when intra-month volatilities of the S&P500 are increasing or high. Long/Short Equity This strategy entails taking short and long positions in stocks expected to, respectively, decrease or increase in value.

Hedge fund managers can either sell short stocks considered to be overvalued or buy stocks they perceive as undervalued. Generally, there will be positive equity market exposure of the funds. Within the same sector in Long/Short Equity trading, the funds match the stocks. For example, for the semiconductor stock, they would be long for a company like Intel Corp and short for NVIDIA Corp., essentially giving the hedge fund exposure on either side of the trade (Boyson 1794). If the trader invests 70% and 30% of its funds in long and shorting stocks respectively, the net exposure would be the difference between 70% and 30% (40%), without using leverage.

These strategies are expected to perform best during the recovery phase of the market cycle during which the curve moderately slopes upwards. Declining risk equities or premiums and volatility are indicative of favorable performance. Fixed Income Relative Value This strategy aims at exploiting the anomalies in interest rates, particularly in the larger and liquid Pacific Rim, European, and North American markets. Commonly traded financial instruments and products under this strategy include futures contracts, interest rate swaps, and government bonds.

This strategy also targets market conditions with long-term pricing blunders in the fixed-income global markets. This enables traders to capture anomalies in relative values through multi-product trades which include Bond versus Bond, LIBOR versus Bond, and Yield Curve (Stowell 69). These three trades, respectively, identify and trade mispriced bonds in comparison to other similar bonds; capitalize on the inconsistency in the spread between Libor Curves and Bond; and trade the LIBOR yield curve by combining swaps and futures that have varying maturities.

This strategy is expected to perform best during the phase of the market cycle with steep positive yield curves and high long-term rates. Performance is also expected to be above average when credit risk premiums are either reduced or high. Event-Driven These strategies focus more on the bigger picture and entail circumstances in which the principal investment risks and opportunities are associated with given events. An example of the bigger picture in this sense may include the current situation in Syria.

These strategies explore events of corporate transactions to secure investment opportunities such as liquidations, consolidations, bankruptcies, recapitalizations, and acquisitions (Boyson 1803). Hedge fund managers that use event-driven strategies take advantage of inconsistencies in valuation in the market both before and after certain events, enabling them to take positions based on the predicted movement of the targeted securities. These strategies are typically on the lookout for whatever item that can shift the market either down or up, and many firms scan headlines around the world searching for as little as a few seconds of lead time.

There are also events referred to as special situations, which impact a company’s stock value and they include the sale of assets and restructuring (Boyson 1803). Potential risks are embedded in situations such as, for example, mergers or acquisitions do not turn out as speculated. These strategies are generally expected to perform best during a bull market and also aim to realize risk-adjusted returns throughout the full market cycle. Works Cited Boyson, Nichole. “Hedge Fund Contagion and Liquidity Shock.

” The Journal of Finance 65.2 (2010): 1789-1816. Print. Stowell, David. An Introduction to Investment Banks, Hedge Funds, and Private Equity: The New Paradigm. New York: Academic Press, 2010. Print.