Hedge Fund 101 (4)

hedging strategy

There are more than 20 investment strategies commonly used by hedge funds, and their techniques can be classified into five categories.

long and short positions

That is, buying and selling stocks at the same time, either net long or net short position

market neutral

i.e. buying underpriced stocks and selling overpriced stocks at the same time.

hedge for changing shares

That is, buying underpriced convertible bonds while shorting the underlying stocks and vice versa.

global macro (finance)

The classic definition of a global macro strategy is a leveraged long and short trade on any asset class (stocks, bonds, currencies, commodities, etc.), any investment instrument (cash, derivatives, etc.), and any capital market in the world, in order to profit from macroeconomic trends.

Global macro strategies have the following four characteristics.

The investment universe is very broad: Global Macro Strategies is probably the most widely invested category of hedge funds, with a presence in almost every major market (stocks, bonds, currencies, commodity markets, etc.) and it scans the world for investment opportunities.

This would give hedge funds the opportunity to look for profit opportunities at any given time, because when a financial market is lacking in opportunity or liquidity The global macro hedge fund does not need to stick to this market, it can look for opportunities in other markets. For example, Soros, the famous macro hedge fund magnate, could have chosen the pound as a sniper in 1992, or he could have chosen the pound as a sniper in 1992. Profits were made by shorting the baht in 1997.

Top-down macro research: the word "macro" in global macro means that the profitability of this type of hedge fund investment is based primarily on. Macro analysis, which attempts to use macroeconomic fundamentals to identify future trends or mispricing in the prices of various financial assets. At the same time, due to the large number of markets involved in global macro strategies and the flexibility of investment strategies, it is difficult to program trading through quantitative models. Therefore, global macro strategies are usually based on subjective decision making judgments.

Mostly directional: Global Macro is not usually market neutral and will use long/short bets on the direction of asset price movements, such as long US equities or short Japanese bonds, so timing is everything for Global Macro, which places a high demand on the fund manager's understanding of global macro economics.

The use of leverage: global macro often uses leverage when placing bets on a particular direction of investment, so its returns and risks are both magnified . Directional investing and the use of leverage make global macro strategies inherently more volatile, and if judged correctly, investors can gain Huge profits and, conversely, equally huge losses.

Managed Futures

That is, holding long and short positions in various derivative instruments.

Definition of professional terms

Short-set

That is, to buy stocks as a short-term investment is to sell the stocks purchased in the short term first and then sell them when their stock price falls Buy it back for the spread (arbitrage). Short sellers almost always borrow someone else's stock to short ("long position" means to buy it yourself). (Stocks as long-term investments). Short-side strategies are most effective in bear markets.

If the stock market does not fall but rises, the short-setter bets on the wrong direction of the stock market, you must spend a lot of money to buy back the appreciating stocks and eat into the losses. The average investor does not use this investment strategy due to the high risk involved.

Lending Bar

"Leverage" has multiple meanings in the financial world, and its most basic meaning is "leverage". Usually it refers to the use of credit to expand one's capital base. Credit is the lifeblood and fuel of finance, and access to Wall Street (funding markets) through "lending" creates a "symbiosis" with hedge funds. " (symbiosis) of relationships.

In high-stakes financial activities, the "lending bar" becomes an opportunity for Wall Street to provide leverage to the big players. Hedge funds borrow capital from the big banks, and Wall Street provides services such as buying and selling bonds and logistical offices. In other words, armed with bank loans, the hedge fund in turn throws a lot of money back to Wall Street in the form of commissions.

Operation

In the initial hedging operation, the fund manager purchases a stock and simultaneously purchases a certain price and time-sensitive put on that stock Put Option (Put Option). The effect of a put option is that when the price of a stock falls below the option limit, the seller of the option can sell the stock he holds for The options are sold at a limited price, thereby hedging the risk of a decline in the price of the stock. In another type of hedging operation, the fund manager first selects a certain type of bullish industry, buys several quality stocks in that industry, and at the same time hedges the price of the options by A certain percentage sells a few inferior stocks in the industry.

The result of this combination is that, if the industry is expected to perform well, the quality stocks are bound to outperform other stocks in the same industry, and the price of the quality stocks will be higher. The gains will be greater than the losses from short selling the inferior stocks; if the expectations are wrong and the stocks in this industry fall instead of rise, then the stocks of the inferior companies will fall by the same amount. If a hedge fund is larger than a quality stock, the profit from selling the short position must be greater than the loss from buying the quality stock down. Because of this approach, hedge funds were used in the early days as a form of fund management for conservative investment strategies to hedge against risk.

However, over time, as people have come to understand the role of derivatives, hedge funds have become more popular due to the following reasons Hedge funds have the ability to make money in bear markets. From 1999 to 2002, general public funds lost an average of 11.7% per year, while hedge funds lost an average of 11.7% per year during the same period. Profits of 11.2%. There is a reason why hedge funds have achieved such impressive results, and the gains they have made have not been as easy as they are made out to be. Almost all hedge funds are managed by exceptional financial brokers.

The financial derivatives that are used by hedge funds (in the case of options) have three main characteristics.

First, it can leverage a larger trade with less capital, which people refer to as hedge fund amplification, typically 20 to 100 times; when the trade is large enough, it can influence prices.

Second, according to Lorenz-Glitz, since the buyer of an option contract has only rights but no obligations, i.e., on the date of delivery, the If the strike price of the option is unfavorable to the option holder, the holder may not exercise the option. . This arrangement reduces the risk to the purchaser of the option while inducing riskier investments (i.e., speculation).

Third, according to John Hull, the more the strike price of an option deviates from the spot of the underlying asset (the particular underlying) of the option price, the lower the price itself, which facilitated subsequent speculative activities of the hedge fund. Once hedge fund managers discovered these characteristics of financial derivatives, the hedge funds at their disposal began to change their investment strategies. They have changed their investment strategy of hedging into manipulating several financial markets by trading large volumes and profiting from their price movements.