20+ Hedge Fund Strategies

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• short GM because you think old vehicles are outdated and they're going to lose value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:

1. Borrowing costs: when shorting a stock, you make a profit by borrowing > selling > buying back the stock after the stock goes down.

2. 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:

1. investing in interest in their securities

2. shorting a stock

3. 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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