Investment strategy of hedge funds, Financial Management

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Investment Strategy OF HEDGE FUNDS

After the Funds are raised from genuine investors, the next step for Hedge Funds is to invest them as per the investment objectives and strategy. Hedge Funds are generally classified according to the type of investment strategy they follow (see table 2). It is important to understand the basis of underlying strategies from various Hedge Funds strategies (see Table 3) because all Hedge Funds are not similar in investment approach. Returns, volatility and risk vary enormously among different Hedge Fund strategies; and how the Hedge Funds are able to diversify investor portfolio and enhance returns are the areas that needs to be verified. Some strategies that are not correlated to equity markets are able to deliver consistent returns with extremely low risk of loss, while others may be more volatile with high returns estimation. Some industry veterans try to categorize Hedge Funds based on their study of appropriate models into various types and formats. Some of the classifications are:

Fung and Hsieh (1997) classify a Hedge Fund's strategy according to both "style" and "location". Here, "style" refers to the type of positions the Fund manager takes, such as going long and short, betting on a particular type of corporate event, or maintaining market-neutrality. "Location" refers to the asset class that the Hedge Fund invests in, such as fixed income, equity, or currencies.

Vikas Agarwal and Narayan Y. Naik classify them into directional and non-directional strategies. Directional strategies refer to those that are dependent on market movements and non-directional strategies that are independent of market movement and profit from either mispricing or effect on pricing of assets due to an expected related event.

Hedge Funds are often segmented according to the asset class that they invest in. There are Hedge Funds trading solely in equities; others specialize in fixed income, sectors, commodities or currencies. They are also grouped on the basis of geographical location of the assets they trade in. For example, some Funds may be focused on European assets while others may be limited to emerging markets and a Hedge Fund that invests in any country is labeled as a global Fund.


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