9 Powerful Hedge Fund Strategies for Novice Investors


Are you considering investing in a hedge fund? Then, you must first understand the fundamentals of these funds, how they make money, and the amount of risk tolerance that you might need. Here are some of the strategies that are most commonly used in hedge funds.

Businessman holding a white paper with printed words Hedge Fund

Long/Short Equity
The very first hedge fund was launched in 1949 using a long/short equity strategy. This strategy has a simple concept, which is that investment research results on winners and losers, so why not place bets on both?

Hedge fund managers using this strategy can decide to purchase the stocks they consider to be undervalued or sell the short stocks they consider to be overvalued. Most of the time, doing this will result to the fund being exposed to the equity markets.

Credit hedge funds often focus on the credit rather than interest rates. There are numerous fund managers who decide to sell short interest rate futures or Treasury bonds in order to hedge their rate exposure. Most of the time, you can rely on the credit hedge funds to prosper during times when credit spreads are narrow which mostly happens during periods of robust economic growth. On the other hand, if the economy slows and the spreads blow out, losses may be suffered.

Short Only
If you tend to err more towards the pessimistic side of things, then the short only hedge funds might be the ones for you. These are also great against bear markets, but are not for the faint of heart.

Market Neutral
Hedge funds suing the market neutral strategy aim for zero net-market exposure. This strategy has lower risk as compared to long-biased strategies, but you should remember that the expected returns are also considerably lower as well.

When using this strategy, hedge fund managers can apply the same basic concepts as long/short equity but minimize the exposure to the broad market. There are two ways you can choose from when implementing this strategy. If the amount of investment in both long and short positions are equal then the net exposure of the fund would be zero.

The other option is to have zero beta exposure. Hedge fund managers will be aiming for investments in both long and short positions in order for the beta measure of the overall fund to stay as low as possible.

In either market neutral strategies, the aim is to remove any impact that the market movements may have on the fund. Additionally, the fund manager will rely solely on his or her ability to pick stocks.

Convertible Arbitrage
Convertibles are considered to be hybrid securities since they combine a straight bond with an equity option. Simply put, a hedge fund using convertible arbitrage is typically long on convertible bonds while taking a short position on a proportion of the shares that they convert into.

Fixed-Income Arbitrage
Hedge funds using this strategy take returns from risk-free government bonds which can eliminate the credit risk. Normally, they use high leverage in order to bolster their supposed modest returns. But by definition, the risk of loss is also higher if the manager ends up being wrong.

Learn more about what hedging is.

Merger Arbitrage
Basically, this is a riskier version of the market neutral strategy. The returns from this strategy are taken from takeover activities. Once a share-exchange transaction is announced, the hedge fund manager can choose to buy shares in the target company as he or she sells short the buying company’s shares at the ratio prescribed by the merger agreement.

There are certain conditions that the deal must abide to such as regulatory approval and a favorable vote made by the target company’s shareholders.

Event Driven
Hedge fund using event driven strategies buy the debt of the companies in financial distress or those who have already filed for bankruptcy. When using this strategy, you need to exercise a considerable amount of patience. Corporate reorganizations can play out for months or years, a time when the operations of the troubled company might further deteriorate.

Global Macro
When comparing to any and all hedge fund strategies, the global macro strategy has the highest risk/return profile. When using this strategy, the fund is invested in stocks, bonds, currencies, commodities, options, futures, forwards and other derivative securities.


There are various hedge fund strategies that you can choose from. A lot of them are not yet discussed here, but the ones that are discussed are conveyed in a way that can be easier to understand but may be more complicated that they seem. There are also hedge funds that use more than one strategy, mostly depending on the assessments of the opportunities they face. Just remember to gather as much information as you can before finalizing your decisions.

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