Directional strategies--investment strategy of hedge funds, Financial Management

Directional Strategies: Strategies in this category involve buying or/and selling securities or financial instruments that the markets believe to be significantly overpriced or underpriced relative to their potential. These strategies include taking bet on the market or security movement forecasting. The profits of Hedge Funds specializing in this area depend on the ability to forecast price accurately as well as predict the exact timing of these movements.

  • Equity Long/Short: This is the most popular form of strategy among the Hedge Funds. The strategy is similar to market neutral strategy but does not promise to hedge against the market risk and solely depends on price movement of the stock. This increases the flexibility of the manager to choose net-long or net-short (positive beta or negative beta) market exposure, while still focusing primarily on stock-selection opportunities.

An important example of equity long/short strategy is pairs trading. It consists of the combined purchase and sale of two securities of similar sector; the rationale behind it being that one security is overvalued relative to the other. Over time, as the market moves itself, the pairs trading strategy should yield positive returns as the prices of two securities converge in long-term irrespective of movements in the general market. Pairs trading is not restricted to equity securities and can be applied in other asset also classes.

Related to this strategy, there are similar other strategies followed in this section; they are:

  1. Dedicated Short Bias: The strategy concentrates on the net short side of the securities on expectation that the market will decline thereby sacrificing the market-neutrality feature.
  2. Dedicated Long Bias: This strategy is converse to the former strategy. It is similar to the long/short strategy, short strategy but the Fund has net long position on securities, and benefits will rely on the anticipation that markets will surge.
  3. Equity Hedge: This strategy is less structured and mostly used by Hedge Funds. It employs bottom-up approach to take advantage of the undervalued and overvalued securities. It can take net long or short position, shift from value to growth option, specific sector to any geographical regions and add leverage to increase capital. 
  4. Global Macro: Global macro strategies invest in all global securities both in developed and developing countries. Fund managers make large bets based on forecasts of major macroeconomic events such as changes in interest rates, currency movements and stock market performance. Macro funds often take on leverage and actively use derivatives. Managers have substantial flexibility and invest in any country or asset class where they see an investment opportunity. This strategy relies on the ability to make superior selection by fund managers as often-investible securities are illiquid and carry high risk due to high correlation of emerging economies. Therefore, the return profile of macro funds is much more volatile than that of other Hedge Funds.
  5. Emerging Markets: A strategy that employs a "growth" or "value" approach to investing in equities without minimizing the systemic risk since in most emerging markets short-selling by institutional investors and foreigners are not allowed. Often fund managers' trade in American Depository Receipts (ADRs) and Eurobonds issued by emerging market companies.
  6. Managed Futures: These are also called as Commodity Trading Advisors (CTAs). These funds specialize in the commodities and financial futures markets, often employing sophisticated computer driven trading programs. These funds tend to use very precise trading rules to capture price movements and focus on short-term price movement patterns. Although historically classified as a separate asset class from Hedge Funds, that distinction being distorted, CTAs are now generally viewed as part of the Hedge Fund industry.


Posted Date: 9/11/2012 2:17:45 AM | Location : United States

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