Types of Hedge Funds

October 23, 2012 in Hedging and Hedge Funds

Various types of hedge funds










Now that you have an understanding of what hedge funds are, let’s look at their different kinds.

Hedge fund categories and types

Hedge funds may be broadly categorised as follows:

Equity – directional hedge funds are focused on stocks and maybe long– or short– oriented. On a net basis, these funds are either long or short in their exposure to stocks. Typically, these could also have a regional or country focus – e.g. ‘Asia/Pacific,’ ‘China,’ ‘US’ etc. or ‘Emerging Markets.’

Debt – directional hedge funds focus on fixed income and debt products, and maybe long or short, but usually are seen to be net long. So you could have hedge funds here that could be long or short or long only. Here too there could be a focus on regional or country-specific debt.

Event-based hedge funds look to generate returns by taking positions in specific situations or events, e.g. mergers and acquisitions, bankruptcy proceedings, distressed asset sales, distressed securities, corporate events such as stock repurchase, dividends and other types.

Global derivative hedge funds, as the name suggests, have a global arena, and use derivatives and other financial instruments to profit from currency movements and macro developments. Another kind is a fund that uses technical analysis and computer-system driven trades to profit from changing trends. These funds may trade a huge variety of assets such as commodities, bonds, interest rate instruments and various types of indices.

Multi-strategy hedge funds are hedge funds that employ various strategies to take advantage of emerging developments in the markets, and do not restrict themselves to a particular strategy or focus. Hence a single fund may be practicing many different investment techniques, each overseen by a specialist manager. Fund of Funds (a fund that invests in other funds) may effect multi-strategy through investing in a variety of specialized hedge funds, each with a different strategy.

Relative value hedge funds seek to profit from miss-pricing or other market inefficiencies that result in a pricing imbalance between pairs of related securities – the fund will buy the under-priced security and short the over-priced one. For example a Convertible Arbitrage fund would look to make a return from a pricing anomaly between a company’s stock and its convertible bond or debenture. Similarly, debt- and diversified arbitrage funds look for such opportunities in global debt markets or across different, but linked asset classes.

Type-wise Fund Assets Under Management

Here’s a graphic illustration of the distribution of the hedge fund AUM across different types as at the end of the Second Quarter of 2012 using data sourced from BarclayHedge.

These categories may change as global sentiments change. It can be seen, for instance, that AUM (Asset Under Management) in the hedge fund category of Fixed Income is the highest at $229.2 billion – this shows investors’ preference for a safer asset category in these troubled times of debt crisis and a global slowdown.

In a ‘risk-on’ environment you would find that funds would flow in greater measure to the equity oriented funds.

Maybe the above discussion would help you find your own fund type – one that meets your investing and risk preferences. Stay tuned as we delve more into hedge funds in later chapters.

You may also check:

1) What are Hedge Funds?
2) Hedge Funds – Pros & Cons
3) Hedge Fund and Long-term Capital Management

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