10 Strategies Hedge Funds Use to Make Huge Returns
Not exactly classroom material, the strategies used by hedge funds nevertheless do not need to be secrets. Some of the strategies below require legal knowhow, others math and statistics. But all of them can categorize themselves as the methods hedge funds employ to reap insane riches. They’re maneuvers not exactly available to the average investor.
We also recommend you to take a look at our previous post on Hedge Fund Strategies.
10. Quantitative or Quant
A quantitative or quant is an investment strategy that follows the numerical methods to take investment decisions, rather than being dependent on human judgement. The hedge fund managers frequently employ several software developers and computer programmers to generate a statistical model that can forecast the market trends, generate assessments for prices and returns, considering all risk parameters.
One of the most famous quants ever…
9. Event-Driven
Event-driven is one of the 10 strategies hedge funds use to make huge returns. In this strategy seeks any market event, such as restructuring, bankruptcy, merger, acquisition, spinoff, etc., that can shift the market up or down. If the hedge fund managers feel optimistic about that event, they may purchase the stocks with the intention to sell later as soon as the price adjusts.
8. Distressed Debt or Distressed Securities
Distressed Debt is an investment strategy, that involves purchasing bonds or stocks from the companies that are either already in default, bankruptcy or in distress. It may become very risky to follow this strategy as many of the companies do not recover the situation so easily. On the other hand, it may earn very attractive huge returns as the stocks are bought at such discounted rates. Sometimes the the hedge funds may in fact run the company.
7. Equity Arbitrage
Equity Arbitrage is a hedge fund investment strategy in which the fund usually tries to take over the ones that are done with, through stock or cash. The idea is that while the acquiring company proposes to trade the acquired company’s share, a hedge fund shortly sells the acquiring company’s share, and simultaneously purchases shares in the acquired company. By purchasing at a lower price and waiting for the transaction to be done, the hedge fund profits from using this strategy.
6. Relative-Value Arbitrage
Relative-value arbitrage is one of the 10 strategies hedge funds use to make huge returns. Following this strategy, a hedge fund manager invests in a pair of correlated securities, such as stock and bond. When the prices of the two securities deviate, that one security increases in value and the other one decreases in value, the investor purchases one security and shorts the other one, till the prices become converged again.
5. Equity Market Neutral
This strategy is based on avoiding all possible and unwanted sources of risk, which is seldom practical in reality. Statistical and fundamental arbitrages are the two main strategies. Statistical arbitrage is based on seeking pricing differences in equities over a period of time, aiming to make a profit on price convergence. Fundamental arbitrage invests in a certain stock considering the company’s future trail.
4. Long/Short Equity
This is one of the 10 strategies hedge funds use to make huge returns. The strategy is based on the idea of buying long equities, with the expectation of increasing value and of selling short equities, with the expectation of decreasing value. It is known as a long/short ‘pair trade’. To make a huge return, the hedge funds should effectively predict the performance of stocks.
3. Short-Only Equity
Short-Only is a hedge fund investment strategy, based on only selling the borrowed shares or stocks that might decrease in worth, with the only purpose of buying them back later at a discounted rate. The risks are always there. If the repurchase rate becomes higher than the original received short sale value, then the investors will make a loss.
2. Long-Only Equity
A Long-Only is a strategy in which a hedge fund takes only long positions, seeks underestimated securities and reduces volatility, along with risk by holding stocks, fixed income, cash or other fundamental assets, basically to make a huge positive return in all market conditions.
1. Leverage or Borrowed Money
This is one of the most popular among the 10 strategies hedge funds use to make huge returns. It follows the tactics of buying more assets by using the borrowed funds, with the confidence of getting more money from the assets than the borrowed amount. The risk of losses is so high that a hedge fund with a huge borrowed amount may often face default or bankruptcy through a business downturn, though a less-levered fund may survive.
