Managing a Portfolio of Hedge Funds 505 Hedge funds can be classified info a number of different sectors and strategies.
Goldman Sachs categorizes hedged funds into four sectors, each of which include a number of strategies. The four sectors are: relative value, event driven, equity long/short, and tactical trading. Equity Long/Short Tactical Trading Convertible Arbitrage Merger Arbitrage Geography (United States, Japan.Europe) Managed Futures Equity Arbitrage Special Situations Industry (Technology. Energy) Global Macro Fixed Income Arbitrage High-Yield/ Distressed Debt Style (Value. Growth, Small) Relative Value: Managers generally identify relationships between securities. When the current pricing relationship deviates from the manager's expectations, trades are structured that will profit when prices revert to their normal relationships. Strategies include convertible bond arbitrage, equity arbitrage, and fixed income arbitrage. Equity arbitrage includes statistical arbitrage and equity market neutral strategies. Event Driven: Managers identify corporate events they expect to affect valuations, and construct trades to extract value when the event occurs. The predominant strategy in this area is merger arbitrage, in which the manager typically buys shares in the target company and sells short shares in the acquiring company, with the expectation that any spread between valuations will disappear upon completion of the merger. Other strategies include special situations, high-yield, and distressed debt. Equity Long/Short: Managers develop views on stocks and express those views by going either long or short in amounts that reflect the manager's conviction about the view. Managers can further express conviction about the views by varying the amount of capital invested, and are able to express directional views by adjusting the net long or short exposure of the portfolio. Most managers tend to have a long bias, but short-biased managers do exist. Specializations within the equity long/short sector are typically along geographic or industry lines. Tactical Trading: Includes both macro managers and managed futures. Macro managers typically develop views on broad economic themes and then implement those views with a variety of instruments. Using either systematic or discretionary approaches, managed futures traders develop views on a variety of markets and typically implement those views through futures contracts and interbank currency forwards. FIGURE 27.2 Hedge Fund Classifications Source: Tremont Advisers, Inc. hedge funds provided earlier was silent on the issue of what strategies qualify as hedge fund strategies, with the only common characteristics seeming to be loose regulation, lack of constraints, and performance fees. Investors may want to further qualify funds they consider for the hedge fund allocations of their portfolios, possibly eliminating managers who are long-only, or who invest in certain securities or regions. Other limitations with respect to style, strategy, and leverage may also help limit the universe to a manageable number of funds.
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