Classifying Fund Strategy

Hedge fund managers chose a research model and appropriate investment approach. These selections can have strategic impacts, and the fund strategy pursued may be based on these selections, or vice-versa. Managers can research actual investments in two differing directions: Top Down research methods or Down Up research methods.

Classifying Fund Strategy: Top Down

A top down approach to investment focuses on the wider picture and looks for firms which benefit from economic projections. Fund managers begin by studying the global economic situation, searching for regional and industrial sectors highly likely to increase in performance. Macroeconomic trends may include employment, growth rates, inflation, interest rates, and exchange rates. They may also research microeconomic trends. After identifying productive industries and sectors likely to do well in the economic situation, fund managers look at the fundamentals of firms or assets likely to bloom or collapse within financial markets. Investments are purchased long or sold short based on this data.

Classifying Fund Strategy: Bottom Up

A Bottom up approach to investment focuses on firms and companies, and expands to the wider economic picture afterwards. The primary focus is firm fundamentals and potential company valuations. After reviewing firms, they expand to wider economic trends relevant to the company’s themselves. Managers enter long or short positions based primarily on firm fundamentals with some concern for greater economic trends.

Hedge fund managers can use a variety of tactics in their attempt to acquire profit. Managers can operate a directional or non-directional fund. Funds are based on their approach to earning market returns.

Classifying Fund Strategy: Directional

A directional fund focuses on directional movements in their investments. Their selections are bets on market movement, which can occur in a positive (long) or negative (short) fashion. They hunt investments they think will provide strong returns in either direction, and capitalize on movements via long purchases and short sales. As a result, they may show higher signs of volatility, and returns are often unsteady.

Classifying Fund Strategy: Non-Directional

Funds may also operate on a non-directional objective. Non-directional funds exploit differences in value between similar assets for profit. These funds attempt to avoid the market’s risks by hunting a stream of exploitable value differences while earning consistent returns. As an example: An asset underpriced in a region may be purchased there and sold elsewhere for a higher price, for instant profit. The returns earned are based on the hedge fund’s ability to find and exploit value differences. The differences in price narrow in as market players exploit them, due to upward pressure on assets purchased and downward pressure on assets sold. These actions simultaneously provide earnings. Once the value differences have disappeared, the assets have reached their price convergence and funds can’t gain profit from their exploitation. Non-directional Funds aim to earn returns which are not reliant on market movements, since value discrepancies can always be found, they do not require positive or negative markets to provide profit. Any strategy which is not driven by market movements is called a market neutral strategy.

Managers have multiple options for analyzing investments. These analysis methods split into two principally used categories: technical or quantitative analysis methods.

Classifying Fund Strategy: Quantitative

Quantitative analysis uses mathematical accounting models to judge assets considered for investment. Numbers derived from financial statements, economics, and business variables are inserted into models constructed from financial equations. These equations calculate desired results, which are compared to desired risk and return levels. The comparison determines if an investment is used in hedge fund strategy.

Classifying Fund Strategy: Technical

Another system for selecting investments, often used alongside quantitative systems, is technical analysis. Technical analysis is chart and graph based: assets are displayed on screen with historical charts and recent trading information. Trading information usually consists of price information, featuring openings, closings, highs, lows, price changes, and other potential categories. They also display volume information, which shows the amount of assets actively trading in prior moments. Volume is typically displayed in millions of the assets, scaling downwards for smaller capitalizations. Assets are traded based on graphical and informational similarity to historical trading platforms. These trades are sometimes executed by human traders, but are also traded electronically by computer systems programmed to recognize trends and patterns down to the millisecond.