What are the main fixed-income hedge fund strategies?

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AcadiFi · Accepted Answer

Fixed-income hedge funds use leveraged long-short strategies to exploit mispricings, term-structure dynamics, and macro views. Main categories:

1. FIXED-INCOME ARBITRAGE (Relative Value)
Long-short trades on small price discrepancies within the fixed-income universe.

- ON-THE-RUN vs OFF-THE-RUN TREASURIES: Newly issued 10-year trades richer due to liquidity premium. Short newly-on-the-run, long off-the-run, capture 5-15 bps as the new bond seasons. LTCM famously used this.

- BASIS TRADES: Long cash Treasury, short futures (or vice versa) to capture CTD option mispricings.

- SWAP SPREAD TRADES: Bet on whether swap rates will widen or tighten vs. Treasuries.

- MBS BASIS: Long MBS, short Treasury duration-matched to capture OAS premium.

Typical leverage: 10-30x. Returns: 6-12% gross, volatility 3-6%. But tail risk is huge — LTCM blew up on convergence trades that diverged.

2. GLOBAL MACRO
Directional bets on rates, currencies, and credit based on macro views.

- CURVE STEEPENERS/FLATTENERS: Long 2y, short 10y (steepener) or vice versa.
- CARRY TRADES: Long high-yielding currencies funded by low-yielding (classic AUD-JPY).
- BREAK-EVEN INFLATION: Long TIPS vs short nominals when you expect inflation to beat break-evens.

3. CREDIT STRATEGIES
- LONG-SHORT HY vs IG: Express views on credit cycle.
- CAPITAL STRUCTURE ARBITRAGE: Long senior, short subordinated when priced incorrectly.
- DISTRESSED DEBT: Buy debt of distressed names expecting recovery or restructuring.
- CREDIT INDEX vs SINGLE NAMES: Long CDX, short basket of names to capture premium.

4. MORTGAGE / STRUCTURED CREDIT
- MBS COLLATERAL SELECTION: Buy pools with favorable prepayment characteristics.
- CMBS / CLO RELATIVE VALUE: Find undervalued tranches.
- NON-AGENCY MBS RECOVERY: Post-2008 popular play.

5. EMERGING MARKET DEBT
- LOCAL vs EXTERNAL DEBT: Trade sovereign bonds in local currency against USD-denominated.
- POLITICAL EVENT TRADES: Bet on election outcomes affecting spreads.

Risks across all: leverage risk, liquidity risk in stress, funding risk (repo lines pulled), correlation risk (in crises, many 'uncorrelated' trades converge).

For CFA Level III alts, focus on fixed-income arbitrage, global macro, and distressed as the main exam-relevant categories.

What are the main fixed-income hedge fund strategies?

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