2.hf strategies

7/28/2019 2.HF Strategies

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STRATEGY CATEGORIES FOR HEDGE

FUNDS

-Jeet R.Shah

M.Com , CFP CM


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INTRODUCTION

In order to compare performance, risk, and other

characteristics, it is helpful to categorise hedge fundsby their investment strategies.

The hedge fund strategy classifications described here

parallel the categories of Goldman Sachs and

Financial Risk Management (FRM).


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INTRODUCTION

Strategies may be designed to be market-neutral (very

low correlation to the overall market) or directional (abet anticipating a specific market movement).

Selection decisions may be purely systematic (based

upon computer models) or discretionary (ultimately

based on a person).

A hedge fund may pursue several strategies at the

same time, internally allocating its assets

proportionately across different strategies.


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INTRODUCTION

Some hedge fund strategies (for example, fixed income

arbitrage) were previously the proprietary domain ofinvestment banks and their trading desks.

One driver for the growth of hedge funds is the

application of investment bank trading desk strategies

to private investment vehicles.


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1. LONG/SHORT

Long/short hedge funds focus on security selection to

achieve absolute returns, while decreasing market riskexposure by offsetting short and long positions.

Compared to a long-only portfolio, short selling reduces

correlation with the market, provides additional leverage,

and allows the manager to take advantage of overvalued aswell as undervalued securities.

Derivatives may also be used for either hedging or leverage.

Security selection decisions may incorporate industry

long/short (such as buy technology and short naturalresources) or regional long/short (such as buy Latin

America and short Eastern Europe).


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2. RELATIVE VALUE

Relative value funds use market-neutral strategies that take advantage ofperceived mispricing between related financial instruments.

Fixed-income arbitrage may exploit short-term anomalies in bondattributes, such as the yield curve or the spread between Treasury andcorporate bonds .

It involves taking long and short positions in bonds & other interest-rate-sensitive securities.

These positions, when combined, approximate one another in terms of rate

and maturity but for some reason are suffering from pricing inefficiencies. Risk varies with the types of trades & level of leverage employed.

In the United States, this strategy often is implemented through mortgage-backed bonds and other mortgage derivative securities.

This strategy has proven to be a very profitable but unpredictable one.

Mortgage securities carry embedded options that are very difficult to valueand even more difficult to hedge.

Many managers have found attractive opportunities overseas, but typicallythey are reticent to disclose the specific nature of their trades.

Portfolio disclosure in this strategy is often nonexistent..


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2. RELATIVE VALUE

Statistical arbitrage involves exploiting price

differences between stocks, bonds, andderivatives (options or futures) while diversifying

away all or most market-wide risks.

Situations for relative-value arbitrage often occur

with illiquid assets, so there may be addedliquidity risk.

Gains on individual trades made be small, so

leverage is often used with relative-valuestrategies to increase total returns.

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EQUITY MARKET-NEUTRAL

STRATEGY PROFILEJeetR.Shah

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EQUITY MARKET-NEUTRAL RISK

PROFILEJeetR.Shah

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3. EVENT DRIVEN

Event-driven strategies exploit perceived mispricing of securities byanticipating events such as corporate mergers or bankruptcies, and theireffects.

Merger (or risk) arbitrage is the investment in both companies (the acquirerand takeover candidate) of an announced merger.

Until the merger is completed, there is usually a difference between thetakeover bid price and the current price of the takeover candidate, whichreflects uncertainty about whether the merger will actually happen.

A fund manager may buy the takeover candidate, short stock of the acquirer,and expect the prices of the two companies to converge.

There may be substantial risk that the merger will fail to occur.

Bankruptcy and financial distress are also hedge fund trading opportunities,because managers in traditional pooled vehicles (such as mutual funds andpension funds) may be forced to avoid distressed securities, which drive their

values below their true worth. Hedge fund managers may also invest in Regulation D securities, which are

privately placed by small companies seeking capital, and not accessible tomany traditionally managed funds.


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CORPORATE LIFE CYCLE


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3A.MERGER ARBITRAGE EXAMPLE.

If the offer in the deal is a cash

offer for stock, the managersimply goes long in the stock ofthe acquired company, withoutthe need to short the acquiringcompany.


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POTENTIAL RISKS IN MERGER

ARBITRAGE.


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MERGER (RISK) ARBITRAGE RISK

PROFILE


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3B. INVESTING IN DISTRESSED

SECURITIES


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3B. INVESTING IN

DISTRESSED SECURITIES

Distressed securities hedge funds invest specificallyin the securities of companies that are experiencing

financial or operational difficulties.

The term distressed securities refers to a wide rangeof financial claims on firms that either have filed forbankruptcy protection or are trying to avoid

bankruptcy by negotiating an out-of-courtrestructuring with their creditors.

The recovery process of distressed companiesgenerally involves several major steps, and distressed

securities managers may focus on specific areas inthis process by extracting value when a catalyst or anevent that changes the price of the securities of thedistressed companies occurs.


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3B. INVESTING IN


Hedge fund managers who specialize in distressedsecurities blend a specialized knowledge of the bankruptcy

process with fundamental analysis of distressed companiesand the intrinsic value of their debt securities and equitiesthat allows them to predict, and when necessary takeactions to influence, the outcome of the bankruptcies andreorganizations.

Distressed securities managers typically invest long andshort in the securities of companies undergoing bankruptcyor reorganization.

They tend to focus on companies that are undergoingfinancial rather than operational distressin other words,good companies with bad balance sheets.

Overleveraged companies that cannot cover their debtburden become oversold when institutional bondholdersliquidate their holdings; as a result, as the companies enterbankruptcy, distressed securities managers buy thepositions at pennies on the dollar.


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3B. INVESTING IN


Often the securities of these companies trade below theirinherent value because of the uncertainty of the companies

future. Furthermore, traditional investors often are restricted from

owning the securities of companies with very low creditratings.

As a result, hedge fund managers often can buy securities

of sound companies with real assets that have not, for avariety of technical reasons, been able to access the capitalmarkets and deleverage their balance sheets. Managersthen look for the instruments to appreciate or be exchangedfor higher-valued securities at various points as thecompany works its way through the restructuring process.

Some fund managers also hedge their portfolio by sellingshort the securities of companies they believe will notrestructure successfully and head toward bankruptcy, aswell as those that will not emerge from bankruptcy.


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3B. INVESTING IN


Distressed managers usually concentrate oncertain sectors and investing styles that fit theirown expertise.

Aspects that differentiate distressed investingstyles include the type of claim instrumentinvested in (i.e., bank debt, corporate debt, tradeclaims, and equities), the phase of thebankruptcy process, and the exit strategy used.


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SECURITIES- TWO BROAD STRATEGIES


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SECURITIES SKILLS REQUIRED

Valuing assets, including locating, collecting, andanalyzing information

Negotiating and bargaining

Understanding the firms capital structure aswell as the legal rights and financial interests of

all other claimholders Risk management, including a thorough

understanding of the specific risks associatedwith investing in distressed situations


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3B. DISTRESSED INVESTING

STRATEGY PROFILE.

2008-09!!!!!!!!!!!!


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3B. DISTRESSED INVESTING

RISK PROFILE.


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4. TACTICAL TRADING

The tactical trading classification includes a largevariety of directional strategies, including the

subcategories of global macro and commoditytrading advisers (CTAs).

Global macro funds make investments based uponappraisals of international conditions, such as

interest rates, currency exchange rates, inflation,unemployment, industrial production, foreign trade,and political stability.

The global macro subcategory tends to contain the

largest hedge funds, such as Robertsons Tiger Fundand Soros Quantum Fund, and they receive themost scrutiny when hedge funds are accused ofundermining global stability.


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4. TACTICAL TRADING

Global macro traders may use leverage, short sales, or

derivatives to maximise returns. Some funds specialise in illiquid assets in emerging

markets, which sometimes have financial markets that

do not allow short sales or do not offer derivatives on

their securities. Commodities trading advisers (CTAs) specialise in

speculative trading in futures markets.


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4. TACTICAL TRADING

Trades may involve futures on precious metals,currencies, financial instruments, or more typicalcommodities in futures exchanges throughout theworld.

CTAs often use computer models to profit fromdifferences in contract selection, weighting, andexpiration. Fung and Hsieh (2001) explain trend-following, the strategy of a majority of CTAs, and howthe strategy can show positive returns, especially inextreme markets. In the U.S., the Commodity Futures

Trading Commission (CFTC), not the SEC, regulatesthe actions of CTAs.


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GLOBAL MACRO STRATEGY OVERVIEW


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MANAGED FUTURES- DEFINED


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IN BOTH UP AND DOWN

MARKETS

Managed futures investors participate in this speculative trading by investing with a CTA.Although hedge funds that engage in futures trading are considered to be managed futures investors,they differ from private pools and public funds in that futures are not the core of their strategy, ratherare a single component of a synthesis of instruments.Managed futures portfolios can be structured for a single investor or for a group of investors.

Portfolios that cater to a single investor are known as individually managed accounts.Typically these accounts are structured for institutions and high-net-worth individuals.As mentioned, managed futures portfolios that are structured for a group of investors are referred toas either private commodity pools or public commodity funds. Public funds, often run by leadingbrokerage firms, are offered to retail clients and often carry lower investment minimums combined withhigher fees. Private pools are the more popular structure for group investors.


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MANAGED FUTURES

Like individually managed accounts, theyattract institutional and high-net-worthcapital.

Private pools in the United States tend tobe structured as limited partnerships

where the general partner is a commoditypool operator (CPO) and serves as thesponsor/salesperson for the fund.

In addition to selecting the CTA(s) to

actively manage the portfolio, the CPO isresponsible for monitoring theirperformance and determining compliancewith the pools policy statement.


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ADVANTAGES OF MANAGED

FUTURES INVESTING Low to negative correlation to

equities and other hedge

funds Negative correlation to

equities and hedge fundsduring periods of poorperformance

Diversified opportunities, inboth markets and managerstyles

Substantial market liquidity

Transparency of positions andprofits/losses

Multilayer level of regulatoryoversight

According to CTAs who use globalfutures and options markets asan investment medium, managed

futures investing differs from hedgefund and mutual fund investing in a

number of fundamental ways,including transparency, liquidity,regulatory oversight, and the use ofexchanges.

Disadvantages

A high degree of volatility High fees

A low level of advisorattention


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