Hedge fund is a form of investment fund where capital is pooled from discerning accredited individuals and institutional investors to invest in diverse variety of assets. Hedge fund is ideally managed by professional portfolio managers to strive to enjoy high returns on their investments. As per Scott Tominaga, hedge funds generally operate as an unregulated alternative investment funds. This basically means that it can employ distinctive types of financial instruments and strategies that are not generally available to regulated pool funds like mutual funds.
Scott Tominaga highlights a few common types of hedge fund strategies
The prime objective of a hedge fund is to generate high returns for the investors, no matter the prevailing market trends. As opposed to traditional investment funds, hedge funds tend to have a higher level of flexibility in terms of the type of investments they may make. Hedge funds can use multiple types of financial instruments, ranging from futures contracts and derivatives to stocks and bonds. Such flexibility enables hedge funds to effectively pursue varied investment strategies to potentially maximize profits.
Here are some of the most common types of hedge fund strategies:
- Long-short strategy: This strategy involves taking both long positions and short positions. Long positions imply to purchasing assets that are expected to rise in value, while short positions involve selling assets expected to decline in value. Long-short strategy aims at generating returns by effectively capitalizing on both bearish and bullish market conditions. Hedge fund managers try to mitigate market risk by pairing long and short positions. The fund managers also attempt to profit from their investment insights.
- Arbitrage strategy / relative value strategy: Arbitrage involves exploiting price discrepancies between related markets or securities in order to generate profits. The arbitrage strategy puts emphasis on capturing low-risk or risk-free opportunities by simultaneously buying and selling assets that have similar characteristics but different prices. Relative value strategy additionally focuses on identifying assets that are mispriced relative to each other.
- Event-driven strategy: Event-driven strategies tend to involve investing in securities of companies expected to be impacted by major corporate events, like bankruptcies, acquisitions, mergers or even regulatory changes. Hedge fund managers try to capitalize on price movements that result from such events.
- Global macro strategy: The global macro strategy involves capitalizing on geopolitical events and macroeconomic trends that impact the financial markets. Hedge fund managers typically analyse factors like global events, economic indicators, government policies and interest rates in order to make investment decisions across diverse markets and asset classes.
In the opinion of Scott Tominaga, Hedge funds typically operate as limited partnerships, where both institutional and accredited private investors contribute capital to the fund. The fund manager, acting as the general partner, is responsible for making investment choices and managing the activities of the fund. When the fund gains value, the limited partners share in the profits in proportion to their investments. In such a structure, limited partners face limited risk. This means that their potential losses are restricted to the amount they initially invested. The general partner, however, has unlimited liability.
