Hedge Funds
A hedge fund is a privately organized capital pool intended primarily for the purpose of investing in publicly traded and over-the-counter securities markets, much like a mutual fund or a unit trust. Hedge funds invest in a variety of securities. Unlike mutual funds, hedge funds may use return-enhancing tools such as leverage, short sales, derivatives, and arbitrage and are often not registered with the Securities and Exchange Commission.
A key advantage of hedge funds is their ability to employ flexible investment strategies. Hedge funds can take both long and short positions; utilize futures, options and other derivatives. Additionally, hedge funds are able to adapt their strategies to take advantage of market opportunities in both rising and declining markets. The primary aim of many hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.
For more information on ING’s hedge fund offerings, please contact us.
Hedge Fund Strategies
Hedge fund strategies vary enormously. The strategies used by hedge funds can be classified into four broad categories:
1. RELATIVE VALUE: strategies attempt to take advantage of relative pricing discrepancies between different types of investments including equities, debt, futures and options. Managers employ mathematical, technical or fundamental analysis to determine mis-valued investments. Investments may be mis-priced relative to an underlying security, relative securities or the overall market. Positions are frequently hedged to isolate the discrepancy and minimize market risk. Relative value strategies typically entail the lowest risk of hedge fund strategies. The risk/return profile is geared towards lower returns accompanied by lower volatility.
2. EVENT-DRIVEN: strategies center on investing in securities of companies facing major corporate events. Mergers and acquisitions are the most common types of events on which this strategy focuses. However, other corporate events such as restructurings, spin-offs and significant litigation also present opportunities. This strategy is research intensive and requires continual review of announced and anticipated events. The goal of these strategies is to uncover investment combinations (both long and short, or either long or short) that exhibit favorable risk and reward characteristics based on the probability that the event will occur. Event-driven strategies are typically higher risk than relative value strategies but lower risk than long/short equity and tactical trading.
3. LONG/SHORT: equity strategies invest either long or short or both long and short are the most common types of hedge fund. These strategies frequently employ bottom-up fundamental research to identify equity securities that should either perform well (in which case the securities will be held long) or that should perform poorly (in which case the equities will be sold short). Most typically, these managers will hold some combination of both long and short positions that will at least partly offset one another to minimize market risk. Long/short equity strategies can take on significant risk, as the underlying stocks can be volatile. Additionally, some managers may not have a fully hedged position, which exposes them to market risk.
4. TACTICAL TRADING: strategies invest over the widest variety of markets and security types. These strategies tend to be based on top-down economic analysis and are usually directionally biased (unhedged) and are opportunistic in nature. These strategies typically have the least restrictions and may offer the greatest opportunities to capitalize on investment opportunities. They also may present higher potential risks. Tactical trading includes strategies such as global macro, market timing, managed futures and emerging markets.
Key Benefits of Investing in a Hedge Fund
- Many hedge fund strategies have the ability to generate positive returns (alpha) in both rising and falling equity and bond markets. In addition, many hedge funds have a track record of preserving capital in falling markets.
- Hedge funds provide opportunities for reducing portfolio volatility by delivering returns that have little or no correlation with broad market benchmarks and by extension, traditional asset classes.
- The variety of hedge fund investment styles – many uncorrelated with each other – provides investors with a wide choice of hedge fund strategies to meet their investment objectives.
- Hedge funds offer greater liquidity (generally quarterly) than many other alternative investments since they may invest primarily in marketable securities.
