1. Long/Short equity (or pairs trading)
one of the most common trading strategies
buying/long a stock (which you think is going to appreciate in value)
simultaneously shorting another stock (which you think is going to depreciate in value)
it's more about a relative value than a stock beating the market
Example:
long Tesla because you think that technology is going to improve the industry
short GM because you think old vehicles are outdated and they're going to lose value
Profitable if:
Tesla appreciates more than GM
GM loses more value than Tesla
2. Short only
more of a niche strategy because only a few hedge fund managers get this right
rely heavily on financial modelling
deep dive into the company's fundamentals, sector, the whole business structure, etc
Problem with shorting stocks:
Borrowing costs: when shorting a stock, you make a profit by borrowing > selling > buying back the stock after the stock goes down.
Short squeeze: when you force short sellers to cover/sell out that position it inflates the market (e.g. Bill Ackman - Herbalife).
3. Long only
only invest in long only fund
4. Event driven (or global opportunistic)
global macro strategies (strategy #7) tend to be very event driven by nature
when you wait for a particular catalyst to take place in the world or an event
Example:
COVID 19
→ every government imposed a lockdown
→ no one is going to be using their cars or flying on planes
→ demand for oil is going to go down
→ oil futures are going to collapse
"US oil prices turn negative as demand dries up"
Different names:
a lot of global macro fund (i.e. funds which invest in fixed income, commodities and currencies (FICC)) tend to be event driven by nature, but they don't call themselves event driven
easier to raise capital from investors when categorized as a "global macro fund"
also called global macro or opportunistic fund or multi-strat funds
5. Activist investing
when a hedge fund buys a controlling stake in a company and get a board seat to force the board to take different actions > that will appreciate the stock price
the opposite of (the usual) passive investing: invest in a particular stock / index / fixed income security and then waiting for the stock to get repriced
6. Sharia Compliant fund
a hedge fund strategy which is compliant with the Islamic religion (relatively new strategy)
if you do follow the Islamic religion then you're prohibited from:
investing in interest in their securities
shorting a stock
certain industries you can invest in
7. Global macro
trading FICC (fixed income, commodities and currencies)
what separates global macro from other strategies is capacity
FICC market is huge - in the trillions (not like in the billions for equities)
funds which have 10 billions+ of assets = tend to be very macro driven
Global macro traders vs Equity traders
global macro strategy: current affairs / economics driven (need to understand economics geopolitics and current affairs)
equity strategy: business world in the deal making space (need to understand capital structures, equity valuation, financial modelling)
8. Market neutral
one of the best performing hedge funds, Citadel - one of their flagship funds is based on a market neutral strategy
when you target a zero beta
having no directional bias with the market and not correlated with major index
Example:
portfolio of $100
$100 long tech stocks
$100 short health care stocks
gross exposure = 200
net exposure = 0
Beta (exposure to the market) = 0
9. Fund of funds
when a hedge fund invests in other:
hedge funds,
VC funds,
real estate funds,
PE funds - to achieve diversification
10. Quant fund
stakeholder cap quant funds or quantitative funds: tend to be maths / financial modelling / algo heavy
3 important characteristics:
1) Trading frequency
high frequency: in and out of hundreds of trades within a second
low frequency trading: a system which gives buys and sell signals e.g. CTA
2) Trading venue
OTC markets
exchanges
dark pools
specialist markets
private market
3) Operational cost
IT systems (infrastructure cost)
human capital (to build and maintain)
data pack
office expenses
11. Fix income
one of the largest markets (a world of its own because of how huge the market is)
a lot of overlap with other strategies
12. Distressed investing
provide capital to a distressed company that is either about to go into bankruptcy or currently in bankruptcy proceeding, in order to restructure their business and emerge profitably
with a high level of risk there's also a high level of reward
a very niche area (bankruptcy proceeding, bankruptcy law, financial modelling)
13. Merger arbitrage ("merg arb")
all about taking advantage of mergers and acquisitions
whenever a company announces that they're going to acquire another company and they have a share target price in mind
risk of deal failing = target price - current price
Example:
Alphabet announces that they want to buy ABC for $6
ABC has been trading at $4
the moment Alphabet announces that they want to buy for $6, instantly that stock is going to jump to around $5.50
best case scenario: acquisition goes through and ABC share at $5.50 eventually goes to $6
downside (much bigger): could potentially go back to $4 in terms of a risk and reward strategy
risking $2 to make only $0.50
not all merge up traders trade equities, some traders will actually buy debt or convertible note
convertible note: invest in convertible bonds which pays the investor a coupon and gives the ability to redeem face value of bond for equity shares
so instead of only targeting that $0.50 upside if you are buying the convertible note you can get a much bigger upside
14. Credit arbitrage
should not be confused with fixed income or fixed income investing
essentially trading the spread
15. Relative value
a lot of assets tend to be correlated
e.g. gold and silver - if gold moves up, silver tends to move up as well = provides an opportunity
16. Convertible arbitrage
was very famous back in the 1990s
some of the world's legendary traders started off by doing convertible arbitrage
a type of trade which is inherently hedged by default
Example:
buy a bond / convertible bond / convertible note in a company
this convertible bond starts off as a regular bond where you get your regular coupon payment
at maturity you get your $100
but instead you have the option to convert that $100 in to company's shares (at a prefix price)
whilst you're also implementing this you're simultaneously shorting the stock
so if the stock goes down instead you get a profit, but you also get to keep your coupon from going on the long side from convertible bond
if the stock did go up you can convert your bond into shares
17. Volatility Trading ("VIX trading")
VIX measures the volatility of a market (inverse of S&P)
if the market goes down the VIX tends to go up
so if you wanted to hedge the market you can go long the market or short the VIX
18. RIsk parity
19. Special situation
20. Unique investments
alternative markets (e.g. luxury cars, wine, yachts)
some hedge funds would even finance litigation - if you want to sue a company but you don't have the means to finance your lawsuit, you can go to hedge fund to raise the capital and they will negotiate a profit and loss schedule
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