Hedge Fund Strategies: Part Four

shanghai-hedgethink Hedge Fund Strategies: Part Four

In part three we looked at equity market neutral strategies and convertible arbitrage.

In part four we give you an in-depth guide to some more common hedge fund strategies.

Distressed

This event-driven strategy focuses on companies that are in financial trouble. The event could be bankruptcy, restructuring, a distressed sale or any other form of corporate event that can be exploited, and positions in debt or in equity can be both long and short.

Many hedge funds using this strategy purchase securities, expecting that the security will increase in value based on fundamentals or current management’s strategic plans.

However, some fund investing in distressed securities take a far more active role in proceedings, getting heavily involved in loan workouts or restructurings, and in some cases even take positions on the board of directors of companies in order to help turn them around.

Whichever tactic is used, the distressed strategy means purchasing bonds that have lost a substantial amount of value due to a company’s financial instability or investor expectations that the company is in dire straits. It could also be that a company is coming out of bankruptcy, allowing a fund the opportunity to buy up low-priced bonds if their evaluation deems that the company’s situation will improve enough to make these bonds more valuable.

The pros and cons: not surprisingly, this strategy can be a risky one, as it relies on a company being able to improve its situation – something that all too often doesn’t go to plan. However, because these distressed securities are traded at such a deflated price, the risk-adjusted returns can prove very attractive.

Emerging Market

Emerging market strategists invest in fixed income securities and stocks in developing countries that have emerging financial markets, most commonly in long positions. Returns are often the result of mispricing opportunities as well as substantial growth. However, success with this strategy does depend on a great deal of manager research and an in-depth “local” knowledge of these emerging markets, which are often inefficient.

This strategy can be risky due to the lack of defensive financial aides available, and simple because of the very nature of the underlying market. The uncertainty cause by economic or political instability, a lack of information or research by fund managers, poor accounting, and the often amateur nature of the investors can see the level of risk increase with emerging market funds.

Fixed Income Arbitrage

Funds using this strategy seek to profit from price discrepancies in related fixed income instruments. One of the main goals of this strategy is to neutralise interest rate risk. It involves offsetting long and short strategies of fixed income securities and derivatives.

Typically, it is a non-directional strategy that tends to yield small margins of profit that are then leveraged. Managers here can seek out mispricing opportunities in a range of hedging trades, such as cash versus futures, long and short credit anomalies, corporate versus Treasury yield spreads, and more. It’s a strategy that grew notably in popularity in the 1990s.