In this paper, we sought to provide three perspectives:
1. Understanding different types of hedge fund sub-strategies.
Hedge fund strategies offer investors four important benefits:
1. Extending the opportunity set – for an instrument selector, being able to short sell an instrument and/or asset class expands the opportunity set to outperform. Given most active managers are limited by shorting constraint, assets with negative outlooks are often mispriced.
2. Idiosyncratic ‘alpha’ opportunity – Returns and risk are driven primarily by instrument picking and leverage from shorting can allow a manager to extend stock ideas without taking a higher market risk.
3. Process and signal diversification – Short sales are often managed using a different investment process than long-only. Therefore, alpha streams from long-short strategies are less correlated to long-only manager alpha.
4. Market risk management – Long-short strategies have the flexibility to vary systematic or market exposure. Short positions can act as a hedge against market risk during difficult economic conditions, bear markets and side-ways markets with shorter and sharper economic and business cycles.
Our analysis of the hedge fund universe track record over the past 1,2,3 and 5 years shows that the various sub-strategies have generally delivered strong risk-adjusted results for investors or, at the very least, performed in a manner true-to-style:
1. Have delivered strong up-market and down-market capture ratios by taking advantage of risk-management flexibility offered by removing short constraint in portfolio management.
2. Have delivered very strong Sharpe and Sortino ratios and materially less drawdown risk than the major asset classes of equities and bonds.
