What are different types of Hedge Funds?

1. What are different types of Hedge Funds?

2. Introduction • Hedge funds are a type of alternative investment fund that employ well-planned strategies to protect their overall portfolio while making good profits. Hedge funds are generally classified into three most popular categories – long-short funds, market-neutral funds, and event-driven funds.

3. Long-short funds • These hedge funds use the long-short investment strategy, which involves taking long positions in stocks whose values are expected to rise and short positions in stocks whose values are expected to fall. The main characteristic of long-short funds is that they employ a strategy that tries to minimize stock market exposure while making profits from long positions on stocks and price drop in the short positions. Even if this may not be the scenario every time, long-short funds ensure that their strategy keeps them net profitable, which means that long positions get more profits than short positions or vice versa.

4. Market-neutral funds • Market-neutral funds are a sub-type of the long-short funds. However, market-neutral funds tend to hedge against general market movements, which is why these hedge funds are named market-neutral. Market-neutral funds are considered aggressive funds that strive hard to provide superior returns to the investors through balancing the bullish stocks that they pick with the bearish stocks. Moreover, these funds can generate income through the interest received on short securities’ sales. The major goal of market-neutral funds is to provide the investors with consistent returns of 3-7% above those provided by T-bills. An interesting fact about these type of hedge funds is that they provide returns similar to leveraged ETFs. These ETFs generally strive to deliver returns in the range of 200-300% on any investment.

5. Event-driven funds • Event-driven hedge funds try to take advantage of various events that include M&A and company restructuring. These events more often result in mispricing of a company’s stock in the short term. Thus, event-driven funds tend to focus on exploiting this declining tendency of companies’ stocks prices. Generally, investors often express concern on occurrence of corporate events such as company restructuring, business reorganization, M&A, or other such events. This concern of investors often tends to lead to a stagnation of the stock price of that company. This continues until the investors start feeling comfortable again with regards to the company’s business stability. Thus, when an event-driven fund finds potential investments such as the company mentioned above, it will first evaluate the company’s underlying value while gathering more inputs on the situation that surrounds an event's his could include potential regulatory loopholes. If the event-driven fund has a general positive perception or feeling pertaining to the corporate event and the company’s strength, it might buy that company’s shares for selling them later when the share price adjusts.

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