Hedge funds are not regulated as strictly as other forms of investments, such as mutual funds. This helped it garner the attention of many investors who wants to play the game on their own terms. Hedge fund provides them freedom but comes under regular reporting and regulations in certain countries such as the US. You have to keep every step carefully in a volatile world of hedge funds.
Different hedge funds strategies works well in different cases and has their pros and cons. You need to choose the right strategy by looking at your needs and market situations of hedge funds. A correct choice of strategy can take you one-step closer to your success. Analyze different factors before choosing a hedge fund strategy. Some of the most popular strategies used in hedge funds are:
It uses a combination of two separate strategies and merges them. In this strategy, hedge fund managers sells short stocks that are overpriced and buy stocks that are undervalued. The fund will not use any leverage and will also give a chance for positive exposure to equity markets for hedge funds. The trades that occur through this strategy are also known as fair trade. The best thing about using this strategy is the hedge fund will gain experience for both buying and selling which would benefit hedge fund managers in the long run.
If both short and long amounts become equal, the net exposure of the funds would be equal to zero. This strategy works best for sideways trading markets. Any aggressive motion either upwards or downwards would eliminate the effect of one side. Another way that is used to execute this strategy is to invest in both short and long positions so overall beta measure is kept to a minimum. The biggest advantage of this strategy is that it completely removes the effect of market fluctuations and depends on your ability to select stocks.
Relative Value Arbitrage
This strategy is normally preferred by those hedge funds that trade debt. The hedge fund manager will buy a stock whose value is expected to increase while selling stock whose value is expected to decline in the near future. This strategy is a combination of different strategies as well. The equilibrium value can be calculated using this strategy. In simple terms, it is all about making the most of price differences between selling and buying price. Leverage is applied in this strategy just to make more profits.
It is a type of relative value arbitrage. This strategy is for those who want to play around with both convertible bonds and stocks. Convertible bonds can be converted into a number of shares. The hedge fund manager will buy the convertible stock and sell the stock short when anticipating a price hike. If both occur simultaneously, this strategy would yield more benefit to the fund manager. Fluctuation in the interest rates will also affect the price of the convertible bonds. The number of options you have for converting bonds into stocks could also play a role in changing the price of the convertible bond.
A distressed debt strategy forces you to buy bonds that have lost its value significantly due to the poor financial situation of the company it belongs to. There might be many factors for the low prices of bonds but hedge funds following this strategy will buy cheap bonds by looking at the indicator. If the indicators say that improvements will come in future, hedge funds will buy those bonds.
This is one of riskiest hedge fund strategies because you are buying bonds in the expectation that its price will improve. If the improvements do not come, then all your money will be lost. The low cost factors will attract hedge fund managers towards buying the bonds. Most of the hedge funds do not take a chance with this strategy but other more adventurous ones test it out.
There are many other hedge fund strategies as well but which strategy works best for you is your decision. The results from hedge funds will depend on the strategy you use. Using the wrong strategy will only bring losses and noting else. Dig deeper and analyze each factor carefully before choosing a hedge fund strategy.
Chris Turner is a versatile content writer with a passion for technology, finance, Investing and trading. He writes extensively on the subjects of Trading, Investing, Bitcoin, Forex trading, investing and general finance. He is writing and providing advice, education and encouragement to budding investors and traders, on Hedge Fund and alternative investments and other emerging financial trends. He is a contributor writer for HedgeThink.com and TradersDNA.com.