Can someone break down the main hedge fund strategies and when each is used? I keep mixing them up.

Question

AcadiFi · Accepted Answer

Hedge fund strategies can feel overwhelming, but they fall into four broad families based on what drives returns. Here is a decision framework you can use:

```mermaid
graph TD
  A[Hedge Fund Strategy Selection] --> B{Primary Return Driver?}
  B -->|Equity Mispricing| C[Equity Hedge]
  B -->|Corporate Events| D[Event-Driven]
  B -->|Spread Convergence| E[Relative Value]
  B -->|Macro Themes| F[Global Macro]
  C --> C1[Long/Short Equity]
  C --> C2[Market Neutral]
  C --> C3[Short-Biased]
  D --> D1[Merger Arbitrage]
  D --> D2[Distressed Debt]
  D --> D3[Activist]
  E --> E1[Fixed-Income Arb]
  E --> E2[Convertible Arb]
  E --> E3[Pairs Trading]
  F --> F1[Discretionary Macro]
  F --> F2[Systematic/CTA]
  F --> F3[Managed Futures]
```

**1. Equity Hedge Strategies**

These strategies profit from stock selection. A **long/short equity** fund buys undervalued shares of, say, Thornhill Biotech while shorting overvalued Kingsley Pharma. The net exposure can range from heavily long (80/20) to market neutral (50/50). **Market neutral** funds explicitly hedge out beta so returns depend entirely on alpha. **Short-biased** funds maintain net short exposure, profiting in bear markets.

**2. Event-Driven Strategies**

Returns come from corporate catalysts. **Merger arbitrage** example: Greenleaf Industries announces it will acquire Northstar Packaging at $42 per share. Northstar currently trades at $39.50. The fund buys Northstar at $39.50, capturing the $2.50 spread if the deal closes. Risk is deal failure. **Distressed debt** funds buy bonds of companies near bankruptcy — for instance, purchasing Belmont Energy bonds at 35 cents on the dollar and recovering 60 cents through restructuring. **Activist** funds take large stakes and push for change (board seats, spin-offs).

**3. Relative Value Strategies**

These exploit pricing discrepancies between related securities. **Fixed-income arbitrage** might buy an off-the-run 10-year Treasury yielding 4.35% and short the on-the-run issue yielding 4.28%, betting the 7 bps spread narrows. **Convertible arbitrage** buys a convertible bond (long cheap volatility) and shorts the underlying stock to isolate the embedded option.

**4. Global Macro**

The broadest category. Funds take directional bets on currencies, interest rates, and commodities based on macroeconomic views. A discretionary macro fund might short the yen if it forecasts Bank of Japan policy divergence. Systematic/CTA funds use trend-following algorithms across futures markets.

**Key Exam Distinctions:**

| Strategy | Primary Risk | Liquidity | Leverage |
|---|---|---|---|
| Long/Short Equity | Equity market | Moderate | Low-Moderate |
| Merger Arb | Deal completion | Moderate | Moderate |
| Fixed-Income Arb | Interest rate | Low | Very High |
| Global Macro | Multiple | High | Varies |

**Common CFA Level I Pitfall:** Students confuse relative value with event-driven. The key difference is that relative value profits from *pricing convergence* between similar instruments, while event-driven profits from a *specific corporate catalyst*.

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Can someone break down the main hedge fund strategies and when each is used? I keep mixing them up.

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