The Ultimate Guide To Hedge Fund Strategies: Types & Examples

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The Ultimate Guide To Hedge Fund Strategies

There are a considerable number of options when it comes to investing. Often, the choice of the investment approach depends on the investor’s short-term and long-term goals as well as the capital. If you are lucky with investments, have good financial health, and need something more strategic and exclusive, hedge funds can be a go-to option. As of 2023, there are about 30,000 hedge funds globally, with the overall value of assets under management being more than $5 trillion

Here is a detailed guide to hedge funds, their types and examples, and the role of technologies like virtual data rooms in hedge funds.

What Is A Hedge Fund?

A hedge fund, in the simplest of terms, is a pool or collection of investments managed and invested by accredited or certified/institutional fund managers. Hedge funds are basically group investments that professional fund managers or recognized institutions manage by using different hedge fund strategies.

It is important to note that there is a limited partnership between investors and fund managers. From the definition above, it may sound like hedge funds are just like any other investment type. However, they are not. Here is how hedge funds work.

How Do Hedge Funds Work? Hedge Funds Explained

A hedge fund is a special kind of investment where fund managers try to balance the risks. They might invest in one sector, like the travel industry, and at the same time invest in another sector, like energy. The core idea is to diversify the investment to avoid a sudden financial collapse.

The fund managers use riskier strategies and deal with complex financial agreements. It is important to note that although hedge funds have a great reputation in the investment industry, they are a riskier venture, so having good financial health for the investor is necessary.

What’s more, when investing in a hedge fund, the investor usually has to leave it there for a minimum of one year (lock-up period). So, investing in hedge funds is not like putting money in a piggy bank where it is easy to withdraw whenever investors want — it is more complicated.

Strategies Used By Hedge Funds

Hedge funds managers employ different strategies for risk minimization. Here are some of the most commonly used ones.

Merger arbitrage

Risk arbitrage, also known as M&A arbitrage strategy or merger arbitrage strategy, is the process of buying and selling securities (at the same time) of the companies involved in an acquisition or merger deal.

The core objective of the merger arbitrage strategy is to capture the price difference between the expected future value and the current price of those securities once the deal is completed.

Global macro

Global macro is a type of hedge fund strategy in which the fund managers focus on large-scale economic trends and events, equity indices, commodities, interest rates, and betting on currencies. It is a high-risk hedge fund strategy that requires precision in predicting global economic trends.

Event-driven strategy

An event-driven investing strategy focuses on generating profits from events like bankruptcies, mergers and acquisitions, and other similar corporate transactions.

Again, the event-driven investing strategy is a riskier one because the success of the investment is based on the outcome of certain events. Fund managers employ strategies like merger arbitrage in event-driven investments.

Equity short/long

In this strategy, the fund managers buy (long-term) and sell (short-term) positions in the stock market. The objective of this strategy is to generate profit from falling and rising stock prices.

Following this strategy requires great skills in market timing, stock picking, and risk management. The idea is to generate excess returns via stock selection rather than focusing on overall market movements.

Distressed debt

In this strategy, fund managers invest in companies’ debts that are in dire financial trouble. The idea is to profit from a potential restructuring or turnaround.

Investing in such companies requires an in-depth analysis of the legal aspect of a company’s debts, its financial situation, and the pragmatic chances of recovery.

Examples of hedge funds

Below is the list of the few notable hedge funds as of 2022:

  • Eliot Management Corporation. Eliot Management Corporation has a highly reputable long history in the hedge funds sector for the last 55 years. The company has approximately $50 billion in assets and mainly invests in the energy sector.
  • Bridgewater Associates. They are a global force with assets totaling $235 billion. Bridgewater is known for providing massive returns on investment. For example, the company provided a massive 32% return in the first half of 2022.

Role Of Virtual Data Rooms In Hedge Funds Management

Virtual or online data room software is a digital document repository used to store, manage, or share corporate data during M&A, capital raising, crowdfunding, real estate, and hedge funds investments.

Hedge funds can use data room software to:

  • Safely share internal and external data with investors, stakeholders, and concerned parties
  • Simplify data management and access process with the help of advanced data room features like automatic indexing, smart search, or full-text search
  • Protect highly confidential corporate data from external and internal threats
  • Communicate freely and safely on a unified platform

Final Words

Hedge funds are collective investments managed by certified institutions or professionals. 

Most common hedge fund strategies include event-driven investment strategy, M&A arbitrage strategy, distressed debt investment, and global macro. Notable hedge funds include Bridgewater Associates, Man Group, Eliot Management Corporation, and Two Sigma.

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