Gary D. Halbert President & CEO

Here is a brief description of the most common hedge fund styles as provided by various Internet hedge fund performance reporting websites.  This list is not exhaustive as many hedge fund providers slice and dice the various funds in different ways when describing them.  In addition, new hedge funds are being developed all the time that expand the universe of valid style descriptions.

Event Driven:

Also known as the Special Situation or Special Opportunity strategy, this style seeks to capitalize on events that are expected to impact the price of a specific stock over a short period of time.  These events include corporate restructurings, stock buybacks, bond upgrades, expected earnings surprises, et

This style may also include sub-styles such as Distressed Securities and Risk (Merger) Arbitrage.  For Distressed Securities, the event is usually an impending reorganization or bankruptcy.  In a Risk Arbitrage sub-style, the manager, generally speaking, simultaneously buys stock in a company being acquired and sells short the stock of the acquirer.

As with any strategy that is based upon an expectation, an Event-Driven hedge fund can post significant losses if the actual outcome is different than that predicted by the fund’s manager.

Fund of Funds: 

Just as the name implies, this is a hedge fund that invests in other hedge funds.  Diversification can be across styles by including funds with different strategies, or can be within a single strategy but spread among various hedge funds employing that strategy.

The advantage of the Fund of Funds is that it can allow investors access to highly successful managers whose minimums are too large for the individual investor to reach.  However, a disadvantage is that there is an extra layer of fees added on for the Fund of Funds manager over and above the management fees charged by the selected fund managers.

Global:           

As the name implies, this style involves investments in equities of many different countries.  Various sub-styles also exist for this category.  One sub-category is the International style, where primarily non-US securities are purchased based on global economic conditions.

Another sub-style is the Emerging Market fund, where investments are made in developing countries with less mature financial markets.  A final Global sub-style is the Regional – Established fund, which focuses on opportunities in established markets, such as Europe or Japan.

Long-Only Leveraged:

This is a style that is very near that of many mutual funds, in that it seeks to buy and hold securities hoping to take advantage of growth in their price.  The use of leverage makes this style more risky, so some practitioners call this the Aggressive Growth style.

Stocks may be selected for this style based on fundamental analysis of the company’s business, or through a technical analysis of the stock’s price movements, or both.  As a practical matter, Long-Only funds may use short sales as a hedging technique from time to time.

Macro:           

This is the classic opportunistic type of hedge fund made famous by such investors as George Soros.   Rather than seeking to profit from a move in a particular corporate security, the Macro (short for macroeconomic) style seeks to profit from shifts in global economic trends.  For example, this type of fund may be long or short in various international stock indexes and currencies, and at the same time attempting to take advantage of changes in the relative economic climates among countries.

The Macro style uses derivatives and leverage extensively, so the risk can be high if the markets perform differently than expected. 

Managed Futures:

This type of fund invests in listed financial and commodity futures markets and currency markets around the world. 

While this type of fund is listed by some sources as a hedge fund strategy, I believe that there is a sufficient structural difference in these funds to merit their own category under “Alternative Investments.”  Therefore, this type of fund will be discussed in greater detail later on in my Alternative Investments series.

Market Timing:

This type of hedge fund tries to predict when to be in and out of the markets, switching among stocks, bonds, and cash, depending upon the current market environment and economic climate.

Market Neutral:            

As I discussed briefly above, this is the “classic” form of the hedge fund, though variations of this theme have been created in the years since 1949.  The goal of all truly Market Neutral hedge funds is to minimize the market risk inherent in securities by using short sales.  I say “truly” because there have been plenty of so-called “market neutral” hedge funds which were anything but neutral in the recent bear market.

In a Long/Short strategy, the net exposure to the market is balanced by allocating equally to long and short positions, although this can vary from fund to fund. 

There are also various Arbitrage strategies such as Convertible Arbitrage, Risk (Merger) Arbitrage , and Fixed Income Arbitrage.  In these strategies, the manager seeks to take advantage of temporary pricing inefficiencies in the market by trading a portfolio of carefully selected long and short positions. 

As mentioned above, the Risk (Merger) Arbitrage style can also be classified as an Event-Driven strategy.                                   

Opportunistic:            

As the name implies, this style describes a hedge fund whose manager uses various strategies and asset classes, depending upon current market conditions.  This provides the manager with complete flexibility, but also requires him to be a “jack of all trades.”

This style is similar, but not identical to the Several Strategies style, in which the manager employs various predetermined strategies to diversify his approach to the market.  The various strategies are employed simultaneously in the fund, but allocations to each of the various styles can vary over time.

Sector:            

In addition to the other strategies employed by hedge fund managers, some employ these strategies only within a defined sector of the market.  For example, a hedge fund may focus on  financial services, or healthcare, or media/communications or technology sectors of the market to the exclusion of all others.

Short-Only:            

This style is the opposite of the Long-Only style, in that it only shorts the stocks of companies the manager feels are overvalued and ripe for a downward correction.  As with the Long-Only strategy, many funds are biased toward short positions, but may also hold long positions in some securities at times.

Value: 

This is a primarily equity-based style in which the manager seeks to find stocks that are undervalued based on the intrinsic worth of the business.  As a hedge, the manager may also take short positions in companies he feels are overvalued.