Characteristics, Uses and Taxation of Investments - Hedge Fund Style and Structure Types



d
. Relative Value Arbitrage - relative value seeks opportunity among mispriced securities with the wager of eventual price convergence. Arbitrageurs determine misvaluation by several means including fundamental, technical and quantitative analyses.

    1. Convertible Arbitrage - the manager looks to exploit the pricing anomaly between a convertible bond and the underlying shares into which it may be converted by purchasing the bond and selling short the stock. The desired outcome would be to gain on both the short sale as well as the long position and shield the portfolio from market volatility. Leverage is a common ingredient. Risks include event, credit, liquidity and interest rate.
    2. Fixed Income Arbitrage - this style is quite broad, with the common denominator of exploiting pricing differentials across global fixed income markets. Market disruptions and investor preferences often give rise to such anomalies. Examples of such strategies are, to wit: sovereign debt arbitrage, yield curve arbitrage, corporate v. treasury yield spreads, municipal bond v. treasury yield spreads and asset backed securities arbitrage. Opportunities may arise through the existence of tax loopholes, volatility differences between security types and markets and points along the yield curve. Leverage is employed to enhance returns.
    3. Equity Market Neutral (statistical arbitrage) - the attempt to take advantage of pricing anomalies between related equities and minimize exposure to systematic risk. This methodology is highly quantitative with the manager taking offsetting long and short positions in equal measure between what s/he perceives to be overvalued and undervalued stocks. Overlaying this approach is an eye toward insulating the portfolio from market volatility. Market neutral does not equate with long/short.
    4. Index Arbitrage - the manager is long securities in the index and short the index derivative in an effort to take advantage of perceived mispricings.
    5. Mortgage-backed Arbitrage - attempts to make money from mispricing between a mortgage-backed security with prepayment risk and a treasury security that lacks this type of risk.

b. Others - these afford investors greater opportunity for diversification, but also another layer of fees beyond those imposed by the underlying managers themselves.
    1. Fund of Funds (fund of hedge funds) - this strategy selects several hedge fund managers with different styles in an effort to achieve more efficient diversification resulting in greater return for less risk. The fund may allocate among several managers within a specific strategy or to several different strategies.
    2. Multi-Strategy Funds - an individual hedge fund's pursuit of diversification by offering several strategies utilizing a dynamic allocation among them to pursue opportunities born of changing market conditions.

2. Structure Types
    1. 3C-1 Fund: a limited partnership exempt from registration, this structure admits a maximum of 99 accredited investors and usually requires a sizable initial investment of several million dollars.
    2. 3C-7 Fund: a limited partnership as well, it admits qualified purchasers up to a maximum of 499 investors. The minimum is considerably lower, beginning at one million dollars.
    3. Registered, Closed-End Fund: a 1940 Act and/or 1933 Act registered fund, it allows only accredited investors, but in unlimited number and with minimums as low as $25,000.
Limited Partnerships
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: Vanguard Total World Stock

    Learn about the Vanguard Total World Stock exchange-traded fund, which invests in stocks located in numerous countries with a high level of diversification.
  2. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares US Real Estate

    Learn about the iShares US Real Estate fund, which holds shares of equity and nonequity real estate investment trusts incorporated in the United States.
  4. Mutual Funds & ETFs

    ETF Analysis: SPDR Barclays Short Term Corp Bd

    Learn about the SPDR Barclays Short-Term Corporate Bond ETF, and explore detailed analysis of the exchange-traded fund tracking U.S. short-term corporate bonds.
  5. Investing Basics

    What to Cut From Your Portfolio Right Now

    Owning stocks may shortly become too scary for your portfolio. Here's why, and here are some alternatives.
  6. Forex Strategies

    How To Avoid Exchange Rate Risk

    What are the best strategies to avoid exchange rate risk when trading?
  7. Investing Basics

    How AQR Places Bets Against Beta

    Learn how the bet against beta strategy is used by a large hedge fund to profit from a pricing anomaly in the stock market caused by high stock prices.
  8. Investing

    6 Reasons Why Every Investor Should Consider ETFs

    Once you understand the benefits of ETFs, you’ll see how they could be an exciting and smart way to help meet your financial goals. Here some key facts.
  9. Investing News

    Oil or Gold: Which Will Recover First?

    Not sure where oil and gold are headed? The answer is complex.
  10. Professionals

    Boomers’ 401(k)s are Way Out of Whack: What to Do?

    Many baby boomers have been investing heavily in equities in their 401(k)s. Now may be the time to rebalance to avoid huge losses if the market tanks.
RELATED TERMS
  1. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  2. Political Risk Insurance

    Coverage that provides financial protection to investors, financial ...
  3. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  4. Gross Exposure

    The absolute level of a fund's investments.
  5. Priori Loss Estimates

    A technique used by insurance companies to calculate loss reserves.
  6. Value Of Risk (VOR)

    The financial benefit that a risk-taking activity will bring ...
RELATED FAQS
  1. Is my IRA/Roth IRA FDIC-Insured?

    The Federal Deposit Insurance Corporation, or FDIC, is a government-run agency that provides protection against losses if ... Read Full Answer >>
  2. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  3. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  4. How does being overweight in a particular sector increase risk to a portfolio?

    An investor who is overweight in a particular sector risks a loss in value for the portfolio if there is a downturn in that ... Read Full Answer >>
  5. What are the primary risks an investor should consider when investing in the retail ...

    The retail sector consists of companies operating in multiple industries such as specialty retail, general retail, food and ... Read Full Answer >>
  6. What risks do I face when investing in the insurance sector?

    Like all equity investments, insurance companies present investors with market risk. Insurance companies, like banks, also ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!