Hedge funds are private investment vehicles aimed to generate positive absolute returns for institutional clients and high-net-worth individuals.
Coupons are paid every six months. Maturity is assumed to be the same for both bonds. Assume that a company has two outstanding bonds: They are both first-lien claims on the company's assets and they both expire on the same day. However, the amount of this premium is often out of equilibrium, creating an opportunity for a hedge fund to enter into a transaction to take advantage of the temporary price differences.
I have used a fairly large spread in the premium to reflect a point. In reality, the spread from equilibrium is much narrower, driving the hedge fund to apply leverage to generate a meaningful levels of returns.
Convertible Arbitrage This is one form of relative value arbitrage.
While some hedge funds simply invest in convertible bonds, a hedge fund using convertible arbitrage is actually taking positions in both the convertible bonds and the stocks of a particular company. A convertible bond can be converted into a certain number of shares.
In a convertible arbitrage transaction, however, a hedge fund manager will purchase the convertible bond and sell the stock short in anticipation of either the bond's price increasing, the stock price decreasing, or both.
Keep in mind that there are two additional variables that contribute to the price of a convertible bond other than the price of the underlying stock. For one, the convertible bond will be impacted by movements in interest rates, just like any other bond. Secondly, its price will also be impacted by the embedded option to convert the bond to stock, and the embedded option is influenced by volatility.
Even if they are incorrect and the relative prices move in the opposite direction because the position is immune from any company-specific news, the impact of the movements will be small. A convertible arbitrage manager, then, has to enter into a large number of positions in order to squeeze out many small returns that add up to an attractive risk-adjusted return for an investor.
Once again, as in other strategies, this drives the manager to use some form of leverage to magnify returns. Learn the basics of convertibles in Convertible Bonds: Distressed Hedge funds that invest in distressed securities are truly unique.
In many cases, these hedge funds can be heavily involved in loan workouts or restructuringsand may even take positions on the board of directors of companies in order to help turn them around. You can see a little more about these activities at Activist Hedge Funds.
That's not to say that all hedge funds do this. Many of them purchase the securities in the expectation that the security will increase in value based on fundamentals or current management's strategic plans.
In either case, this strategy involves purchasing bonds that have lost a considerable amount of their value because of the company's financial instability or investor expectations that the company is in dire straits.
In other cases, a company may be coming out of bankruptcy and a hedge fund would be buying the low-priced bonds if their evaluation deems that the company's situation will improve enough to make their bonds more valuable. The strategy can be very risky as many companies do not improve their situation, but at the same time, the securities are trading at such discounted values that the risk-adjusted returns can be very attractive.
Conclusion There are a variety of hedge fund strategies, many of which are not covered here. Even those strategies that were described above are described in very simplistic terms and can be much more complicated than they seem. There are also many hedge funds that use more than one strategy, shifting assets based on their assessment of the opportunities available in the market at any given moment.
Each of the above strategies can be evaluated based on their potential for absolute returns and can also be evaluated based on macro- and microeconomic factors, sector-specific issues, and even governmental and regulatory impacts.HFRI® Broadly constructed indices designed to capture the breadth of hedge fund performance trends across all strategies and regions.
HFRX® Daily indices utilizing a rigorous quantitative selection process to represent the larger hedge fund universe.
11 Most Popular Hedge Fund Strategies - It's important to join a hedge fund with an investment strategy that fit you in order to have longevity in this career.
Today we'll go over the most popular hedge fund strategies. Let's start with an overview of the hedge fund industry. There are many different hedge fund strategies available to hedge fund managers.
Choosing a strategy that will produce the highest returns within the acceptable. Hedge Fund Trading Strategies Detailed Explanation Of The Long Short Margin Ratio Hedge /30 80/20 /60 25/75 / A Moderate Strategy Aug 1, by An Investing Newsletter, Hedge Strategies.
Paperback. $ $ 12 99 Prime. FREE Shipping on . Directional hedge fund strategies include US and international long/short equity hedge funds, where long equity positions are hedged with short sales of equities or equity index options.
Within directional strategies, there are a number of sub-strategies. Hedge fund strategies are employed through private investment partnerships between a fund manager and investors A hedge fund is an investment fund created by accredited individuals and institutional investors for the purpose of maximizing returns and reducing or eliminating risk, regardless of .