20+ Hedge Fund Strategies

hello everyone and welcome back in this video we're going to be taking a look at 20 of the most common hedge fund strategies which you will find at some of the world's leading hedge funds and don't forget to stick around to the end of this video where i'll show you where you can download all the materials from this video so let's begin one of the most common strategies is what's known as long short equity this is one of the most common trading strategies and pretty much it involves buying a stock which you think is going to appreciate in value and then simultaneously shorting another stock which you think is going to depreciate in value so for example let's just say that you are a long tesla because you think that technology is going to improve the industry and then your short gm because you think old vehicles are outdated and they're going to lose value so this particular trade it's only going to be profitable if tesla gets more value or appreciate more than gm or vice versa if gm loses more value than tesla now when it comes to long short equity or pairs trading as it's sometimes known it's more about a relative value than a stock beating the market so here when we're concerned that tesla is going to outperform gm or gm is going to underperform tesla we're not so concerned about tesla beating the market or gm beating the market here it's all about relative value now let's move on to another hedge fund trading strategy and this is more of a niche strategy because only a few hedge fund managers out there actually get this right and this is short only hedge funds so some hedge funds they specialize in just going short and just shorting a particular stock now short only funds rely heavily on financial modelling deep dive into their and the company's fundamentals in trying to identify if a company is just bsing that if they are overstating their accounts receivable that if they have committed fraud in their books if they've been cooking the books if management has been uh overspending if the company has been mismanaged so you really need to understand your particular sector and you really need to understand the whole business structure in order for you to be really successful at identifying particular shorts now the problem with shorting stocks is you have two main issues number one you incur borrowing costs essentially when you are shorting a stock you first have to borrow it sell it and then eventually after the stock goes down you buy it back and that's how you make a profit number two you are susceptible to short squeeze essentially what a short squeeze is is when you force short sellers to have to cover that position and you pretty much uh make them you pretty much inflate the market now the problem with short squeeze is the fact that you can lose a lot of money and you can pretty much just take a look at bill ackman and he was caught on the wrong side of the herbalife trade when he was up against carl icahn so let's move on to a different strategy now the secular camp the opposite of a short only fun which is a long only fun pretty much very plain vanilla long only fun they only invest in alongside not much to say about this and there are a lot of funds which just specialize in just long only so let's move on to a far more exciting strategy and this says event driven and global opportunistic now in terms of event driven strategies this is a very broad because you tend to find a lot of global macro strategies which we'll talk about later on but a lot of global macro strategies they tend to be very event driven by nature and event driven what this means is essentially when you wait for a particular catalyst to take place in the world or an event for example brexit or covid19 whenever something like this happen it creates an opportunity in the market so for example we've covered 19 when pretty much every government imposed a lockdown on every nation preventing people from leaving their their homes this means that no one is going to be traveling so no one's going to be using their cars no one's going to be flying on planes so demand for oil is going to go down so if the mars is going to go down for oil then the price has to go down and if price goes down for oil then all future is going to collapse and then like we saw oil features went down to the negative territory so when you whenever you're talking about event driven strategies it's pretty much they they pretty much depend a lot on on what's happening around the world they need a catalyst in order to justify particular trade and once they identify the particular catalyst now it's all about structuring the trade what's interesting about event driven strategies is that a lot of global macro fund so funds which invest in fake fixed income commodities and currencies they tend to be event driven by nature by by the history of their trade but they don't call themselves event driven and that's because whenever they're going to raise capital from investors there's a lot more capital to be raised if you categorize yourself as a global macro fund as opposed to an event-driven fund where there's not damaged capital so you often find a lot of global macro fund they are actually heavily involved in event driven but they just call themselves global macro or opportunistic fund or multi-strat funds but if you are interested in learning more about these particular strategies in a lot more detail actually see examples and know exactly how to structure a particular trade as well as the whole a to z of the asset management world and the hedge fund world then do check out the asset management and hedge fund interview and recruitment guide where we pretty much break down the whole 80z of the industry from what you'll be doing on a day-to-day basis to strategies to start to structuring your trade and to even structuring a pitch in order to ace your interviews as well as going over interview questions and answers so do check that out and i'll leave a link in the description below so let's move on to another strategy and it's like activist investing now activist investing is pretty much the opposite of passive investing passive investing is pretty much done by most hedge funds now typically a hedge fund or even any regular type of fund they're very passive in nature so they will invest in a particular stock in an index in a fixed income security and then they'll just wait for the the stock to get repriced right that's very passive now activist investing on the other hand is very different this is when a hedge fund will buy a controlling stake in a company and then they'll get a board seat and then go and actually force the board to take different actions that will make the stock price higher or to to to appreciate nano circular cast a relatively new strategy which has come up in the hedge fund world and this is sharia compliant hedge funds and essentially what sharia compliant hedge funds is it's a hedge fund strategy which is compliant with the islamic religion if you take a look at the middle east it's famous for two things number one oil number two money now something else which is interesting is that in the middle east and in parts of northern africa islam is the dominant religion and as a consequence this there are criterias in terms of investing so if you if you do follow the islamic religion then you're prohibited from investing in interest in their insecurities you can't go short a stock and there are other requirements such as industries which you can invest in now typically traditional hedge funds they don't cater to that and as a result there's been a new buff of of hedge funds which cater predominantly to that particular market and they're known as sharia compliant hedge funds and you'd be surprised but there are a lot of them right now and if you go into places like the middle east north africa southeast asia like malaysia or indonesia that it's so it's a really booming market and even in london europe and the us they're trying to attract that capital so they are starting to cater to that in london one of the biggest trivia compliant fund is oss crescent they have tens of millions under management so it's a really booming market so now let's move on to number seven i think one number seven and let's take a look at global macro now as i've already alluded to before global macro as a strategy is very broad but predominantly in the global macro world you're trading thick now fixed stands for fixed income currencies and commodities and essentially in this world in the world of global macro a lot of the strategies tend to be event driven but you also have other strategies which is in the global macro space but you're pretty much in global macro if you're trading indices uh fixed income currencies anything which is not stock related but even that some global macro fund would even trade stocks as well what separates global macro from other strategies is capacity now whenever you have funds which manages tens of billions hundreds of billions and in the case of bridgewater associates which manages over 170 billion they have a problem of capacity you see if they were to invest in stocks and let's just say they want to invest in a company whose market cap is 500 million now they have 170 billion there's only so many of these companies that they can invest in or that they can actually find enough shares that they can buy or sell so there is a capacity constraint but when they are investing in global macro they don't have that constraint anymore because you can pretty much buy as much currency as you want as much commodities as you want as much indices as you want because the market for indices currencies commodities is huge the world of fixed income is it's huge it's in the trillions it's not like in the billions for equities in the world of commodities fixed income currencies we're talking trillions of dollars so you have a lot more capacity to trade with so whenever you have funds which have 10 billions of assets plus they tend to be they tend to be not always they tend to be very macro driven what's unique about global macro traders versus equity traders is the difference in knowledge if you want to operate if you want to go into the global macro space then you need to have a very good understanding of economics geopolitics and current affairs versus if you want to go into the equity world then you need to understand capital structures equity evaluation financial modeling you need to understand that but it's very different in the macro world where it's pretty much very uh current affairs driven economics driven so depending on your interest if you are far more interested with current affairs of economics then you will naturally gravitate to global macro strategies but if you're far more interested in the business world in the deal making space then you might go into the m a up or equity strategy direction okay so now let's move on to strategy number eight which is market neutral now this is very interesting because one of the best performing hedge funds is by citadel and one that flagship fund actually is based on a market neutral strategy now essentially what market neutral is it's when you target a zero beta so when your portfolio has nearly zero correlation to the market and the way you achieve this is say for example you have a portfolio of 100 and you buy a bunch of tech stocks so you then leverage your portfolio by 100 and then you go short health care stocks right so you have 100 long tech stock 100 which you leverage and your short health care stocks so you're effectively 100 long and 100 short so your gross exposure is 200 but your net exposure is zero and as a result because of the of the long and short in equal proportion your beta exposure so your exposure to the market your portfolio is exposure to the market in terms of direction is zero and that's how you achieve market neutral so let's move on to number nine and this strategy is called funder funds essentially what this type of strategy involves is it's when a hedge fund invests in other hedge funds other venture capital funds other real estate funds other project funds now some of these funder funds will specialize in just hedge funds but essentially the fund manager in a fund of funds uh strategy they're not really selecting or buying stocks instead they're selecting and buying other hedge funds other hedge fund managers because they want to achieve diversification and that's just their aim so they want to invest 10 of their capital in 10 different type of funds and that's essentially how they make their return okay so now let's move on to number 10 and now stakeholder cap quant funds or quantitative funds now these types of hedge funds they tend to be very mass heavy very financial modelling heavy very algo heavy they're not like your traditional typical research and they pretty much invest in a handful of stocks per year these types of fund well depending on their trading frequency can be in and out of hundreds of thousands of stock in any minute there are three important characteristics whenever we're talking about coin funds number one it's the trading frequency now you have some funds which are very active and these are high frequency funds so essentially what a high frequency fund is they will invest and they will trade in and out of securities maybe hundreds or even thousands of time and this can take place within a matter of minutes seconds or even nanoseconds but then on the other hand you have other types of funds which are low frequency and they may trade one or two stocks within a day within an hour but they're much more slower than the high frequency the fund another thing which is important is the trading venue now some funds they will they pretty much trade on a particular venue some will trade in the dark pool finally the third thing is operational cost whenever you go into a crowdfund one of the biggest expenses that they incur is the infrastructure cost because think about it in order for you to build one of these platforms or one of these venues you're going to have to invest heavily on technology so building these super computers that can handle these complicated algorithms that can handle all this data being pumped through it and even the human capital you have to invest heavily on getting really smart people into the door to actually build these argos to actually maintain the argos so it's very very capital intensive to begin with and as a result they're going to have to leverage a lot of their a lot of their trades in order to justify number one making the returns to cover the operational cost and then making a return for their investors so even though they might make pennies on some of their high frequency trades but because they're leveraging those trades it does make sense uh when you when you add them all up okay so now let's move on to number 11 which is fixed income now the fixed income space some hedge fund managers they specialize in just investing in fixed income securities it's a very boring area not as fine or as exciting as equities or global macro but it's one of the largest largest markets out there there's a lot that can be said about fixed income because it's not as simple as just investing in bonds you have convertible notes and this is a a really good strategy which is used in mbn arb so there is a lot of overlap in terms of fixed income and other strategies as well so like global macro which is again fixed income dominated you have m a which can be fixed income dominated if you invest in the in the right capital structure but again fixed income it's a world of its own because of how huge the market is so now let's move on to number 12 and let's just take a look at distressed investing now some hedge funds they invest in just distressed companies whenever a company runs into trouble they are either about to go into bankruptcy or they are currently in bankruptcy proceeding you then have some hedge fund that will that will step in and provide capital that they need in order to restructure the balance sheet or get out of the mess that they're in or to pay off certain creditors so that they can restructure their business and emerge profitably now some of these hedge funds they will pretty much go into these situations now this is a very high risk scenario because again these companies they are on the verge of bankruptcy so you are taking a risk by investing in these companies but the good thing is with a high level of risk there's also a high level of reward because you can pretty much buy these companies for pennies on the dollar both on the equity side and on the debt side so there's a lot of reward to be able to be have on both sides of capital structure and it is a very niche area you do need to know a lot about bankruptcy proceeding bankruptcy law financial modeling you do need to understand how to restructure a business the likelihood of business will emerge profitably out of bankruptcy you do need to have that specialized sense of knowledge in order to operate in the distressed investing world so now let's move on to the 13th strategy and this is merger or merger arbitrage essentially this strategy is all about taking advantage of mergers and acquisitions whenever a company announces that they're going to acquire or buy another company and they have a share target price in mind so say for example google or alphabet announces that they want to buy abc for six dollars and let's just say for example say abc has been trading at four dollars but the moment that google announces that they want to buy for six dollars instantly that stock is going to jump to around five dollars and fifty cent now there's there still is that difference between five dollars and fifty cent and a six dollar target and that's the upside which merger traders are targeting essentially if you're in the merger of space you are essentially buying shares in the hopes that this acquisition is going to go through and that essentially this abc share at 5.50 is eventually going to go to six dollars now the problem with this is your upside is known which is great so you know that in the best case scenario you are going to make that extra 50 but the downside is much bigger because you could potentially go back to four dollars in terms of a risk and reward strategy it's not really good because your upside is 50 cent but your downside is around uh two dollars or one and a half dollars now this is the issue which merger of traders faces so it's all about making sure you don't take extra risk that you don't need to now if they do make a mistake this could potentially set back six trades not all merge up traders trade equities now i know that for those of you that do know or who are familiar with the merger space then you might have heard that it's all about the equity it's all about buying the shares but some traders will actually buy the debt or the convertible note so instead of only targeting that 50 cent upside if you are buying the convertible note you can get a much bigger upside now if you do want to go into this space then you do need to have or you do need to have experience in investment banking or an m a space because you do need that experience that knowledge in putting deals together in knowing if a deal is going to materialize or if it's going to flop or if regulators are going to come in and prevent the deals from going through in the first place so you do need to know how deals are structured capital structure uh the the potential upside you do need to be aware of restructuring laws you do need to to understand the likelihood or you need to have the experience to know whether a deal is exactly going to go through or not and this is why a lot of ex-investment bankers tend to go into this strategy because it suits their their background so now let's move on to another strategy now let's take a look at credit arbitrage now this strategy should not be confused with fixed income or fixed income investing here you're essentially trading the spread so let's move on to another strategy now let's take a look at a relative value now relative value is very interesting because in the world of global macro no and even beyond blue macro even in the equity world in the fixed income world a lot of assets tend to be correlated for example oil and natural gas they tend to be very correlated gold and silver they tend to be very correlated so if gold moves up silver tends to move up as well so this provides an opportunity for example if in a day gold moves up a lot let's just say by five percent but silver hasn't now because of this widening in the price difference in the queen in the spread but you do know that eventually it will have to go back to normal eventually silva will have to either go back up or gold will have to go back down because historically that correlation has been maintained and the market follows a north korean distribution where mean reversion is the norm now that's just the techie side of it but essentially you get what i mean that if gold and silver tend to go up and down in the same manner but if one of them has gone out of whack but eventually they're going to go go back to how they're supposed to be so essentially you can pretty much sell gold if you think that's going to go back down or you can buy silver if you think it's going to go up again or you could do both okay so now let's move on to a different strategy and let's take a look at strategy number 16 which is convertible arbitrage now this was very famous back in the 1990s and some of the world's legendary traders started off by doing convertible arbitrage essentially what convertible arbitrage is it's a type of trade which is inherently hedged by default which is great so for example you you buy a bond you buy a convertible bond or convertible note in a company now this convertible bond starts off as a regular bond where you get your regular coupon payment and then at maturity you get your 100 but a convertible bond instead of getting your 100 at maturity you have the option to convert that 100 in the company's shares what this means is you get a regular coupon payment and that's your upside your profit instantly but then at the end of uh of the bonds maturity aliens lifespan if the stock has gone up you get to convert it at a prefix price now whilst you're also implementing this you're simultaneously shorting the stock so if the stock actually goes down instead well because you've already shorted it you get to profit but you also get it to keep your coupon from going on the long side as well from your convertible bond now you're just not going to convert it you're just not going to convert your bond you're just going to keep the coupon and get your cash out but also benefit from being short the stock but if the stock did go up now your short is going to be in the red but you can cover this position by converting your bond into getting shares and you can then use those shares to cover your short so as long as the company doesn't default you're always going to get your coupon and if the company does go down does decrease in value you're already short the stock okay so now let's move on to strategy number 17. and this is vixx or trading the vix now there are various ways you can trade the fix you can pretty much uh whenever the vix spikes up because of a certain event because of certain movement because of certain announcements in the market the vix tends to be mean reversing where it always tends to go back down so you can pretty much get an option in the vix or you can pretty much just short it out right and you can pretty much do a lot of trades around the vix and again this is the type of topic where it will take me pretty much two hours to cover the vic strategies but essentially vixx trading it's um it's its own security and the vix measures the volatility of a market and it's quite it's negatively it's the inverse of the s p essentially so it's inverse of the market so if you wanted to hedge the market you can go along the market and go short the fix and then you're hedged because if the market goes down the vic tends to go up so other strategies is number 18 you have risk parity number 19 you have special situations again check out those two strategies in the interview recruitment guide where we go into a lot more detail as well as for all the other strategies which we've covered number 20 is special situation or unique situation now this is very interesting uh recently a lot of hedge funds have been created not to invest in the market as other traders would but they invest in alternative markets so say for example they would buy and sell luxury cars they'll buy sell wine they'll buy and sell yachts cars planes so you have hedge funds which invest in alternative types of assets some hedge funds would even finance litigation if you want to sue a company but you don't have the means to finance your lawsuit you can go to hedge fund actually raise the capital and then they will negotiate a profit and loss schedule if you win they get to keep x amount etcetera etcetera but you have hedge funds which are now investing in alternative asset classes and some of these are not even asset classes i mean who finances a lawsuit and considers that to be an asset but again you do have uh hedge funds which are pretty much adventuring throughout the world of of investing and finding new places where they can put capital to good use now again if you are interested in learning more about the world of hedge fund asset management whether that's understanding more about the strategies or about the day-to-day life of an analyst or pretty much the whole a to z of what working at a hedge fund or asset management is like then check out our guide on asset management and hedge funds where we also go over interview prep so so teaching you how to prepare for your stock pitches technical questions and behavior questions and answers so check those out and i'll see you in our next video

Channel: High Finance Graduate

Views: 23,191

Keywords: hedge fund, hedge fund strategies, hedge fund analyst, hedge fund trader, hedge fund interview, hedge fund explained, asset management

Id: J1v89nUWrBA

Length: 26min 24sec (1584 seconds)

Published: Sun Jun 07 2020