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1.
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Definition
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This strategy involves investments,
long or short, in equities. Traditional equity value and growth
hedge funds purchase stocks which they perceive to be undervalued
and sell stocks which they perceive to be overvalued. The
research-intensive efforts employed in identifying promising stocks
to hold long in a portfolio may also provide short-sale
opportunities, and for this reason many directional equity funds
often maintain both long and short portfolios. While the long side
generally outweighs the short side in most directional equity funds,
there is also a small group of short-biased funds in which the short
side as a general matter exceeds the long side, sometimes by a
significant margin.
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2.
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Examples, Types, or
Variations
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Example: A long/short fund manager might
sell
short one automobile industry stock, while buying (taking
a long position) on another -- short of
DaimlerChrysler, long on
Ford.
Thereafter, any general development that improves the yield of
auto industry stocks in general will help this fund's Ford
position, but will hurt its DaimlerChrysler position. Likewise,
any general development that worsens the yield of auto industry
stocks in general will hurt the Ford position, but will help its
DaimlerChrysler position. The two positions are offsetting, so
the portfolio is hedged against developments that affect
the auto industry in general.
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3.
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Formula
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4.
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Related Terms
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5.
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As
Used in the Hedge Fund World
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Market
neutral strategies can be seen as the limiting case of equity long
short, in which the long and short portfolios of the fund are
balanced with great care so that a very high degree of hedging is
achieved.
Strictly, "Market neutrality" just refers to hedging out market
risk, which can be managed through the use of derivatives such as
futures on market indexes. However, market neutral funds usually
seek to hedge against most or all predictable risk exposures. As a
result they are among the least volatile hedge funds.
Other Resources:
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Abria:
Equity hedge strategies involve the combining of long stock
holdings with short sales of stock or indices. Equity
long/short fund managers use a number of different technical and
fundamental measures to determine security selection.
More…
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EIM Group:
The traditional hedge fund approach, first developed in the
1950s, involves taking simultaneous long and short equity
positions, in an attempt to globally neutralize overall market
moves.
More…
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6.
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Applications
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7.
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Misused
& Abused
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There
are many difficulties with managing long/short funds. These include
the difficulties of estimating and hedging the risks to which a
porfolio is exposed, and the requirement to manage unsuccessful
short positions in an active manner. Short positions that are losing
money grow to become an increasingly large part of the portfolio,
and their price can increase without limit.
However, the major difficulty is that to make money the hedge fund
must successfully predict which stocks will perform better. Most
investors grossly underestimate the difficulty of this task. It
requires making intelligent use of the available information, but
this is not enough -- it also requires making better use of the
available information than large numbers of capable investors.
There are significant difficulties in achieving this sort of equity,
which is why only institutional traders and hedge funds engage in
them. Primarily, there is the cost of setting the trades up, of
balancing the portfolio, and picking the index stocks. There are
also additional costs in the 'two for one' arrangement of L/S E,
since basically a manager is gambling the market is unstable. If the
market remains very stable, small fluctuations may ruin him -- his
long position may sink and his short position may rise, leaving him
with nothing.
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8.
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Additional Sources of Information
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Books
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News
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Scholarly Papers
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Back to Terms
| HEDGE FUND RISK AND OTHER
DISCLOSURES |
Hedge funds, including fund of funds (“Hedge
Funds”), are unregistered private investment partnerships, funds or
pools that may invest and trade in many different markets,
strategies and instruments (including securities, non-securities and
derivatives) and are NOT subject to the same regulatory requirements
as mutual funds, including mutual fund requirements to provide
certain periodic and standardized pricing and valuation information
to investors. There are substantial risks in investing in Hedge
Funds. Persons interested in investing in Hedge Funds should
carefully note the following:
- Hedge Funds represent speculative investments and involve a
high degree of risk. An investor could lose all or a substantial
portion of his/her investment. Investors must have the financial
ability, sophistication/experience and willingness to bear the
risks of an investment in a Hedge Fund.
- An investment in a Hedge Fund should be discretionary capital
set aside strictly for speculative purposes.
- An investment in a Hedge Fund is not suitable or desirable for
all investors. Only qualified eligible investors may invest in
Hedge Funds.
- Hedge Fund offering documents are not reviewed or approved by
federal or state regulators
- Hedge Funds may be leveraged (including highly leveraged) and
a Hedge Fund’s performance may be volatile
- An investment in a Hedge Fund may be illiquid and there may be
significant restrictions on transferring interests in a Hedge
Fund. There is no secondary market for an investor’s investment in
a Hedge Fund and none is expected to develop.
- A Hedge Fund may have little or no operating history or
performance and may use hypothetical or pro forma performance
which may not reflect actual trading done by the manager or
advisor and should be reviewed carefully. Investors should not
place undue reliance on hypothetical or pro forma performance.
- A Hedge Fund’s manager or advisor has total trading authority
over the Hedge Fund.
- A Hedge Fund may use a single advisor or employ a single
strategy, which could mean a lack of diversification and higher
risk.
- A Hedge Fund (for example, a fund of funds) and its managers
or advisors may rely on the trading expertise and experience of
third-party managers or advisors, the identity of which may not be
disclosed to investors
- A Hedge Fund may involve a complex tax structure, which should
be reviewed carefully.
- A Hedge Fund may involve structures or strategies that may
cause delays in important tax information being sent to investors.
- A Hedge Fund may provide no transparency regarding its
underlying investments (including sub-funds in a fund of funds
structure) to investors. If this is the case, there will be no way
for an investor to monitor the specific investments made by the
Hedge Fund or, in a fund of funds structure, to know whether the
sub-fund investments are consistent with the Hedge Fund’s
investment strategy or risk levels.
- A Hedge Fund may execute a substantial portion of trades on
foreign exchanges or over-the-counter markets, which could mean
higher risk.
- A Hedge Fund’s fees and expenses-which may be substantial
regardless of any positive return- will offset the Hedge Fund’s
trading profits. In a fund of funds or similar structure, fees are
generally charged at the fund as well as the sub-fund levels;
therefore fees charged investors will be higher that those charged
if the investor invested directly in the sub-fund(s).
- Hedge Funds are not required to provide periodic pricing or
valuation information to investors.
- Hedge Funds and their managers/advisors may be subject to
various conflicts of interest.
The above general
summary is not a complete list of the risks and other important
disclosures involved in investing in Hedge Funds and, with respect
to any particular Hedge Fund, is subject to the more complete and
specific disclosures contained in such Hedge Fund’s respective
offering documents. Before making any investment, an investor should
thoroughly review a Hedge Fund’s offering documents with the
investor’s financial, legal and tax advisor to determine whether an
investment in the Hedge Fund is suitable for the investor in light
of the investor’s investment objectives, financial circumstances and
tax situation.
All performance information is believed
to be net of applicable fees unless otherwise specifically noted. No
representation is made that any fund will or is likely to achieve
its objectives or that any investor will or is likely to achieve
results comparable to those shown or will make any profit at all or
will be able to avoid incurring substantial losses. Past performance
is not necessarily indicative, and is no guarantee, of future
results.
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Any indices and other financial benchmarks
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impact of advisory fees. Investors cannot invest directly in an
index. Comparisons to indexes have limitations because indexes have
volatility and other material characteristics that may differ from a
particular hedge fund. For example, a hedge fund may typically hold
substantially fewer securities than are contained in an index.
Indices also may contain securities or types of securities that are
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fund’s performance may differ substantially from the performance of
an index. Because of these differences, indexes should not be relied
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