A hedge fund is an investment fund created by institutional investors and accredited investors in order to maximize returns and eliminate or lower risk, no matter the market climb or decline. As Scott Tominaga points out, it basically is a type of private investment partnership between a fund manager and the investors of the fund, commonly structured as a limited partnership or limited liability company. Such partnerships operate with little to no regulation from the SEC or Securities and Exchange Commission.
Scott Tominaga underlines some of the major hedge fund strategies
Hedge funds are characterized by riskier investments, thereby magnetizing wealthy investors who want to seek greater returns and are willing to take larger bets. As a strategy, hedge funds are known to be valuable to investors as they tend to provide access to return drivers that are not present elsewhere in their portfolios. Even though the overall level of the stock market is the dominant driver of almost all conventional equity funds, the majority of hedge funds attempt to hedge or minimize their exposure to the broad stock market.
Hedge funds strategies can be of many types, including:
- Global macro strategies: As per such strategy, managers make bets on the basis of major global macroeconomic trends like economic cycles, demographic shifts, currencies, and moves in interest rates. Discretionary and systematic approaches are used in major financial and non-financial markets by effectively trading options contracts, futures, currencies, as well as traditional equities and bonds.
- Directional hedge fund strategies: In the case of the directional approach, managers tend to bet on the directional moves of the market as they expect a trend to reverse or continue for a certain span of time. A manager analyzes the market movements, inconsistencies or trends, which might be then applied to investments in vehicles like long or short equity hedge funds and emerging markets funds.
- Event-driven hedge fund strategies: These strategies are used in situations where underlying risk and opportunity are linked to an event. Fund managers generally find investment opportunities in discerning corporate transactions like bankruptcy, liquidations, recapitalization, consolidations and acquisitions. These transactional events ideally form the basis for investment in risk arbitrage and distressed securities.
- Relative value arbitrage strategies: These strategies take advantage of relative price discrepancies between varied securities whose prices are expected to diverge or converge over time. There are certain sub-strategies coming under this category, like volatility arbitrage, convertible arbitrage, equity market neutral positions and fixed income arbitrage.
- Long/short strategies: Managers make “pair trades” to bet on two securities in the same industry in case of long/short hedge fund strategies.
- Capital structure strategies: Certain hedge funds take advantage of the mispricing of securities up and down the capital structure of a company. For instance, if they think that the debt is overvalued, they may short the debt and go long the equity, thereby creating a hedge and betting on the eventual spread correction between the securities.
As per Scott Tominaga, hedge fund strategies typically aim to provide investors with absolute returns, meaning they seek to deliver positive performance irrespective of whether the broader market is rising or falling.