Alternative Investments

The Hedge Fund advantage.

By design, the primary aim of most hedge funds in to reduce risk and volatility while pursuing positive absolute returns in rising and falling markets. In using alternative investment strategies, hedge funds seek to capitalize on the evolving opportunities in an ever-changing investment environment. As such, hedge funds can play a vital role in the construction of client portfolios.

Hedge funds utilize a variety of strategies to enhance return and minimize correlation with the overall markets. Different types of funds include: Market Neutral, Market Long-Short, Global Macro, Event Driven, and Arbitrage.

The original hedge fund was first created by Alfred Jones in 1949, whose intent it was to balance the movement of the overall market with the movement of individual assets. Since that time, the hedge fund industry has evolved to become one of the world’s largest investment pools at an estimated $1.6 trillion.

Market Neutral
Market neutral fund managers buy securities (long) determined to be undervalued and, in balance, sell securities (short) determined to be overvalued. This creates a defensive position where positive returns can be made from increasing and decreasing prices. The ultimate strategy is to have the long positions outperform to the upside, while the short positions outperform to the downside.

Market Long-Short
Market long-short fund managers build a portfolio that is either net long or net short. That is, the manager chooses to favor exposure of being long or short the market. This strategy can often result in leverage when the proceeds from selling short are used to buy securities and take a long position. To accomplish this, managers can use stocks, options, derivatives and fixed-income instruments.

Global Macro
Global macro fund managers use a strategy to construct a portfolio based on an overall global economic and/or political outlook. Often times this type of strategy can offer high reward with high risk as portfolios are often concentrated and outcomes highly dependent on future uncertain macroeconomic conditions. Global macro funds thus take a big-picture view using top-down analysis.

Event Driven
Even driven managers take significant, often concentrated, positions in companies with the potential for ‘special situations’. These can include: merger-arbitrage, takeovers, bankruptcies, corporate restructuring, and the like. For example, with merger-arbitrage situations, the manager would take a long position in the company being acquired and take a short position in the acquiring company.

Arbitrage
Arbitrage managers can pursue various strategies to achieve returns, namely fixed-income, currency and convertible arbitrage. The overall strategy is to capitalize on market inefficiencies, ultimately capturing return from the mispricing of assets.