Hedge Fund Strategies

Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Are Hedge Fund Strategies?

Hedge fund strategies are a set of principles or instructions followed by a hedge fund in order to protect themselves against the movements of stocks or securities in the market and to make a profit on a very small working capital without risking the entire budget.

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There are multiple strategies that market participants take into consideration, but to understand the best hedge fund strategies, it is important for one to know the pros and cons of each strategy and learn which one would be effective in what instance.

Key Takeaways

  • Hedge fund strategies are a collection of rules or guidelines that hedge fund abides by to safeguard themselves against market fluctuations in stocks or securities and to turn a profit with very little working capital without putting the entire budget in danger.
  • To make an investment decision, a wide range of strategies are used. It uses both quantitative and fundamental methodology. This hedge fund strategy may be broadly diversified or closely targeted at particular industries.
  • Such a hedge fund technique involves buying and selling the stocks of two merging companies simultaneously to generate a risk-free profit.
  • Hedge funds produce some exceptional compounded annual returns. To earn these substantial returns for your investors, you must be able to employ hedge fund strategies correctly.

Hedge Fund Strategies Explained

Hedge Funds do generate some outstanding compounded annual returns. However, these returns depend on your ability to properly apply Hedge Funds Strategies to get those handsome returns for your investors. While most hedge funds use Equity StrategyEquity StrategyAn equity strategy is a long-short strategy on equity stock which involves taking a long position on those shock which are bullish (i.e., expected to increase its value) and taking a short position on stocks which are bearish (i.e., expected to decline or fall its value) and hence booking a sufficient profit from the difference.read more, others follow Relative Value, Macro Strategy, Event-Driven, etc. You can also master these hedge fund strategies by tracking the markets, investing, and learning continuously.

Hedge Funds Video Explanation



The list of most common hedge fund strategies is given below:

  1. Long/Short Equity Strategy
  2. Market Neutral Strategy
  3. Merger Arbitrage Strategy
  4. Convertible Arbitrage Strategy
  5. Capital Structure Arbitrage Strategy
  6. Fixed-Income Arbitrage Strategy
  7. Event-Driven Strategy
  8. Global Macro Strategy
  9. Short Only Strategy

Let us discuss each of them in detail. 

Hedge Fund Strategies

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#1 – Long/Short Equity Strategy

#2 – Market Neutral Strategy

#3 – Merger Arbitrage Strategy

#4 – Convertible Arbitrage

#5 – Capital Structure Arbitrage

  • It is a strategy in which a firm’s undervalued security is bought, and its overvalued security is sold.
  • Its objective is to profit from the pricing inefficiency in the issuing firm’s capital structure.
  • It is a strategy used by many directional, quantitative, and market neutral credit hedge funds.
  • It includes going long in one security in a company’s capital structure while at the same time going short in another security in that same company’s capital structure.
  • For example, long the subordinate bonds and short the senior bonds, long equity, and short CDS.

#6 – Fixed-Income Arbitrage

#7 – Event-Driven

#8 – Global Macro

#9 – Short Only


Let us consider the following examples to understand different hedge fund strategies:

Example 1 (Long/Short Equity Strategy)

  • If Tata Motors looks cheap relative to Hyundai, a trader might buy $100,000 worth of Tata Motors and short an equal value of Hyundai shares. The net market exposure is zero in such a case.
  • But if Tata Motors does outperform Hyundai, the investor will make money no matter what happens to the overall market.
  • Suppose Hyundai rises 20%, and Tata Motors rises 27%; the trader sells Tata Motors for $127,000, covers the Hyundai short for $120,000, and pockets $7,000.
  • If Hyundai falls 30% and Tata Motors falls 23%, he sells Tata Motors for $77,000, covers the Hyundai short for $70,000, and still pockets $7,000.
  • If the trader is wrong and Hyundai outperforms Tata Motors, however, he will lose money.

Example 2 (Market Neutral Strategy)

  • A fund manager may go long in the ten biotech stocks expected to outperform and short the ten biotech stocks that may underperform.
  • Therefore, in such a case, the gains and losses will offset each other despite how the actual market does.
  • So even if the sector moves in any direction, the gain on the long stock is offset by a loss on the short.

Example 3 (Merger Arbitrage Strategy)

Consider these two companies– ABC Co. and XYZ Co.

  • Suppose ABC Co is trading at $20 per share when XYZ Co. comes along and bids $30 per share, a 25% premium.
  • The stock of ABC will jump up but will soon settle at some price, which is higher than $20 and less than $30 until the takeover deal is closed.
  • Let’s say that the deal is expected to close at $30, and ABC stock is trading at $27.
  • To seize this price-gap opportunity, a risk arbitrage would purchase ABC at $28, pay a commission, hold on to the shares, and eventually sell them for the agreed $30 acquisition price once the merger is closed.
  • Thus the arbitrageur makes a profit of $2 per share, or a 4% gain, less the trading fees.

Example 4 (Convertible Arbitrage)

  • Visions Co. decides to issue a 1-year bond that has a 5% coupon rate. So on the first day of trading, it has a par value of $1,000, and if you held it to maturity (1 year), you would have collected $50 of interest.
  • The bond is convertible to 50 shares of Vision’s common shares whenever the bondholder desires to get them converted. The stock price at that time was $20.
  • If Vision’s stock price rises to $25, the convertible bondholder could exercise their conversion privilege. They can now receive 50 shares of Vision’s stock.
  • Fifty shares at $25 are worth $1250. So if the convertible bondholder bought the bond at issue ($1000), they have now made a profit of $250. If they decide that they want to sell the bond, they could command $1250 for the bond.
  • But what if the stock price drops to $15? The conversion comes to $750 ($15 *50). If this happens, you could never exercise your right to convert to common shares. You can then collect the coupon payments and your original principal at maturity.

Example 5 (Capital Structure Arbitrage)

An example could be – A news of a particular company performing poorly.

In such a case, both its bond and stock prices are likely to fall heavily. But the stock price will fall by a greater degree for several reasons like:

Example 6 (Fixed-Income Arbitrage)

A Hedge fund has taken the following position: Long 1,000 2-year Municipal BondsMunicipal BondsA municipal bond is a debt security issued by a national, state, or local authority to finance capital expenditures on public projects related to the development and maintenance of infrastructures such as roads, railways, schools, hospitals, and airports.read more at $200.

  • 1,000 x $200 = $200,000 of risk (unhedged)
  • The Municipal bonds payout 6% annual interest rate – or 3% semi.
  • Duration is two years, so you receive the principal after two years.

After your first year, the amount that you have made, assuming that you choose to reinvest the interest in a different asset, will be:

$200,000 x .06 = $12,000

After two years, you will have made $12000*2= $24,000.

But you are at risk the entire time of:

  • The municipal bond is not being paid back.
  • Not receiving your interest.

So you want to hedge this duration risk.

The Hedge Fund Manager Shorts Interest Rate SwapsInterest Rate SwapsAn interest rate swap is a deal between two parties on interest payments. The most common interest rate swap arrangement is when Party A agrees to make payments to Party B on a fixed interest rate, and Party B pays Party A on a floating interest rate.read more for two companies that pay out a 6% annual interest rate (3% semi-annually) and are taxed at 5%.

$200,000 x .06 = $12,000 x (0.95) = $11,400

So for 2 years it will be: $11,400 x 2 = 22,800

Now, if this is what the Manager pays out, then we must subtract this from the interest made on the Municipal Bond: $24,000-$22,800 = $1,200

Thus $1200 is the profit made.

Example 7 (Event-Driven)

One example of an Event-driven strategy is distressed securities.

In this type of strategy, the hedge funds buy the debt of companies in financial distressFinancial DistressFinancial Distress is a situation in which an organization or any individual is not capable enough to honor its financial obligations as a result of insufficient revenue. It is usually the result of high fixed costs, obsolete technology, high debt, improper planning and budgeting, and poor management, and it can eventually lead to insolvency or bankruptcy.read more or have already filed for bankruptcy.

If the company has yet not filed for bankruptcy, the Manager may sell short equity, betting the shares will fall when it does file.

Example 8 (Global Macro)

An excellent example of a Global Macro Strategy is George Soros shorting the pound sterling in 1992. He then took a massive short position of over $10 billion worth of pounds.

He consequently profited from the Bank of England’s reluctance to either raise its interest rates to levels comparable to those of other European Exchange Rate Mechanism countries or to float the currency.

Soros made 1.1 billion on this particular trade.

Top Hedge Fund Strategies of 2014

Below are the Top Hedge Funds of 2014 with their respective hedge fund strategies –

Top Hedge Fund Listssource: Prequin

Also, note the hedge funds Strategy distribution of the Top 20 hedge funds compiled by Paquin.

Breakdown of Top 20 hedge fund by strategies 1

source: Prequin

Frequently Asked Questions (FAQs)

How do hedge fund strategies differ from traditional investment strategies?

Hedge fund strategies often differ from traditional investment strategies in flexibility, use of leverage, short-selling, and alternative investments. Hedge funds typically have more flexibility in employing various investment techniques and can take advantage of both long and short positions to profit in different market conditions.

Can hedge fund strategies be risky?

Yes, hedge fund strategies can involve higher risks than traditional investment strategies. Hedge funds often employ more complex and sophisticated investment techniques, including leverage, derivatives, and short-selling, which can amplify both potential returns and risks. Additionally, hedge funds may have less regulatory oversight and may operate with less transparency compared to traditional investment vehicles.

Are hedge fund strategies suitable for all investors?

Hedge funds are more suitable for sophisticated investors with a higher risk tolerance, a deep understanding of the strategies employed, and the ability to withstand potential losses.

A guide to what are Hedge Fund Strategies. Here we explain the types of it along with relevant examples and a list of top strategies. You can learn more about accounting and financing from the following articles –

Reader Interactions


  1. kiirran says

    Thanks Dheeraj for layman approach in conveying the message.
    Wonderful and worth the time invested in reading.

    Thanks Again for your help in providing the insight into 2 different worlds which are pretty away from common man.

    • Dheeraj Vaidya says

      Thanks Kirran!

  2. Natasha Kishnani says

    Have read many articles related to Hedge funds strategies, but I found this article full of details and useful content. Great sharing :)

    • Dheeraj says

      thanks Natasha!

  3. Navya Rahulkar says

    Thanks for this Article Dheeraj. I am reading your articles and enjoying them thoroughly. I have the following question, though: If I want to be in Hedge funds, will doing CFA help me?

    • Dheeraj says

      Hi Navya,

      Thanks! If you want to move into Hedge fund, CFA will surely help. Do register for the same.

      All the best,

  4. Akia Orlov says

    Dheeraj another great post. Great!!!

    For Hedge Funds I have heard that there is some minimum investment requirement. I wanted to know if it is the same or does it vary country wise or Fund-wise?

    • Dheeraj says

      Thanks Akia, Since each fund is unique with respect to its strategy and objective, i think the minimum investments requirements would be different depending on the country or the type of fund.