Important Strategies to Profit from Hedge Funds

Hedge funds is basically an investment fund for the riches and the super riches and it’s open to a limited number of investors such as institutional and accredited investors to undertake trading activities with a significant initial minimum investment with aim to offset potential losses in principal market by hedging investments through a wide range of unconventional strategies. Hedge funds primarily focus on reducing volatility and risk with an aim to preserve capital to deliver positive return, so that overall portfolio risk is minimized and return is enhanced.

The investment strategies of hedge funds are many, each offering different degree of risk and expected return. The hedging strategies are built from varied elements including style of hedging such as global macro, event driven, directional, sector specific such as emerging market or technology to methods of hedging such as discretionary or systematic.

One can broadly classify the hedge funds strategy into three broad categories

Event-Driven strategies, Arbitrage Strategies and Directional Strategies. The main aim of the hedgers is to protect them from risk and they employ future market. Prices in the cash market have a relationship with future prices. With the changes in the forces of demand and supply there is a change in the prices of the cash market, future market is expected to grow in a parallel fashion. But, the movement is not of the same amount. It is this pricing anomaly that the hedgers take advantage of.

Some of the very high risk strategies of hedge funds are:

Short Selling: In this method, the fund managers target overvalued stocks and buy them from a prime broker, and then these stocks are sold in the market. As the hedge managers feel the market is approaching a bearish cycle, he repurchases the same stocks at a lower price and sells them back to the broker. In this way, the manager makes profit from a fall in the security value.

Emerging market: Hedge managers invest in equity or debt of less mature economy with the assumption of potential future growth in these economies. However, in many emerging markets short selling is not allowed and hence effective hedging is not feasible.

Macro: These take into account changes into global economies brought about by policy changes that affects all, ranging from currency market, stocks and bonds. It is here that a hedge manager use derivatives and leverage to emphasize the impacts of market moves on overall portfolio.

Moderate risk strategies include:

Event-driven situations such as mergers, takeovers, re-organizations are common and it is here that the hedge managers invest in long or short, in bonds or stocks that are expected to experience a change in price over a very short period of time due to the aforesaid situations.

Investments in other hedge funds: Rather than direct investment to stocks and bonds, hedge managers can invest other hedge funds. This calls for moderate risk and moderate income.

Low risk strategies:

Distressed Securities: Hedge fund mangers often invest in distressed securities such as on stocks of companies that have financial difficulty or are in the process of filing bankruptcy. Because of this prevailing situation, the hedge managers can buy these stocks on discounted prices. The hedge managers can make money when the company again reorganizes and return to profitability.