Many fixed income funds have lower risk tolerances than distressed debt funds and place capital preservation as a higher priority, leading to more diversification and volatility-reducing strategies. A common fixed income hedge fund strategy is fixed income arbitrage, discussed below. Arbitrage strategies seek to exploit observable price differences between closely-related investments by simultaneously purchasing and selling investments.
When properly used, arbitrage strategies produce consistent returns with low risk. However, because price inefficiencies between investments tend to be slight, arbitrage funds must rely heavily on leverage to obtain significant returns. Due to heavy use of leverage, some arbitrage firms have suffered monumental losses when pricing differences unexpectedly shifted including Long Term Capital Management, the infamous fixed income arbitrage fund from the s that suffered catastrophic losses and had to be bailed out by a government-brokered consortium of Wall Street banks. Fixed income arbitrage seeks to exploit pricing differences in fixed income securities, most commonly by taking various opposing positions in inefficiently priced bonds or their derivatives, with the expectation that prices will revert to their true value over time.
Common fixed income arbitrage strategies include swap-spread arbitrage, yield curve arbitrage and capital structure arbitrage. Although simple in theory, proper execution of convertible arbitrage strategies requires careful timing to avoid losses. Furthermore, the increasing popularity of convertible arbitrage has had the effect of diminishing available price inefficiencies, making it difficult to achieve significant returns without using extensive leverage.
A pure relative value arbitrage strategy involves high risk and requires extensive expertise. Merger Arbitrage involves taking opposing positions in two merging companies to take advantage of the price inefficiencies that occur before and after a merger. Upon the announcement of a merger, the stock price of the target company typically rises and the stock price of the acquiring company typically falls.
Merger arbitrage is a form of event-driven hedge fund strategy, discussed below. Event-driven strategies are closely related to arbitrage strategies, seeking to exploit pricing inflation and deflation that occurs in response to specific corporate events, including mergers and takeovers, reorganizations, restructuring, asset sales, spin-offs, liquidations, bankruptcy and other events creating inefficient stock pricing. Event-driven strategies require expertise in fundamental modeling and analysis of corporate events. Examples of event-driven strategies include: merger arbitrage, risk arbitrage, distressed debt, and event-based capital structure arbitrage.
Quantitative hedge fund strategies rely on quantitative analysis to make investment decisions. Such hedge fund strategies typically utilize technology-based algorithmic modeling to achieve desired investment objectives. Funds that rely on quantitative technologies take extensive precautions to protect proprietary programs. Global macro refers to the general investment strategy making investment decisions based on broad political and economic outlooks of various countries. Global macro funds are not confined to any specific investment vehicle or asset class, and can include investment in equity, debt, commodities, futures, currencies, real estate and other assets in various countries.
Hedge Funds do generate some amazing compounded annual returns.
However, these returns depend on your ability to properly apply Hedge Funds Strategies to get those handsome returns for your investors. You can also master these hedge fund strategies by tracking the markets, investing and learning continuously. Thanks Dheeraj for layman approach in conveying the message. Wonderful and worth the time invested in reading. Thanks Again for your help in providing the insight into 2 different worlds which are pretty away from common man.
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Have read many articles related to Hedge funds strategies, but I found this article full of details and useful content. Thanks for this Article Dheeraj. I am reading your articles and enjoying them thoroughly. For Hedge Funds I have heard that there is some minimum investment requirement. I wanted to know if it is the same or does it vary country wise or Fund-wise? Thanks Akia, Since each fund is unique with respect to its strategy and objective, i think the minimum investments requirements would be different depending on the country or the type of fund.
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