What Are the 4 Major Categories of Hedge Funds and How Do They Fit Into Your Investment Strategy?

Hedge funds have long been a key tool for investors seeking to enhance returns, hedge risk, or diversify portfolios. However, not all hedge funds are created equal.

The strategies employed by hedge funds can vary significantly, and understanding the differences between them is essential for building a portfolio that aligns with your investment goals.

Hedge funds can generally be categorized into four major types: Macro & Managed Futures, Event-Driven, Relative Value, and Equity strategies.

Let’s break down each category and explore how they operate in the broader investment landscape.

Macro & Managed Futures

Macro and Managed Futures hedge funds focus on large, top-down bets on global economic trends. These funds often speculate on interest rates, currencies, commodities, and global stock indices. The strategies are typically either discretionary macro, where fund managers make decisions based on their views of global macroeconomic conditions, or systematic commodity trading advisors (CTAs), which use quantitative models to identify market trends and trade accordingly.

Discretionary macro funds rely heavily on the expertise of the manager, who analyzes geopolitical events, fiscal policies, and economic data to make strategic investment decisions. On the other hand, systematic CTAs base their trades on algorithms and statistical models, aiming to capture trends across various markets with limited human intervention.

These funds are attractive for investors looking to gain exposure to broad market trends or seeking to hedge against potential macroeconomic risks. However, they can also be volatile and heavily dependent on market timing.

Event-Driven

Event-driven hedge funds seek to profit from specific corporate events like mergers, acquisitions, bankruptcies, or restructurings. These strategies are highly opportunistic, designed to capitalize on market inefficiencies that arise before, during, or after such events.

Activist funds are well-known players in this space. They actively take large positions in companies and push for changes to unlock shareholder value, such as restructuring or improving governance. Merger-arbitrage strategies, on the other hand, bet on the outcomes of corporate mergers, often buying shares of target companies and shorting the acquirers.

Distressed funds invest in companies undergoing financial difficulty, betting that the company will recover and the asset's value will rise. Finally, multi-strategy event-driven funds combine several of these approaches, allowing for greater flexibility and a more diversified risk profile.

Event-driven funds are often less correlated with broader market movements, making them an appealing option for diversification. However, they are subject to significant deal-specific risks, such as failed mergers or unexpected regulatory interventions.

Relative Value

Relative value hedge funds focus on exploiting pricing inefficiencies between related securities. These strategies aim to profit from price differentials rather than making directional bets on market trends. Often referred to as arbitrage funds, they typically involve complex financial instruments and require a deep understanding of market mechanics.

Convertible arbitrage strategies, for example, take advantage of mispricings between a company's convertible bonds and its equity. Volatility arbitrage seeks to profit from discrepancies between the implied volatility of options and the actual volatility of the underlying asset. Fixed-income arbitrage involves taking advantage of price differences between various fixed-income securities.

Many relative value funds operate with a market-neutral approach, meaning they aim to generate returns regardless of market direction. These funds are attractive to investors seeking consistent returns with lower volatility. However, they can be sensitive to liquidity risks and sudden changes in market conditions.

Equity Hedge Funds

Equity hedge funds are among the most common and well-known categories. These funds primarily invest in stocks, but their strategies can vary significantly, from taking long and short positions in individual equities to more complex market-neutral approaches.

Long-short equity funds, the most traditional type of equity hedge fund, go long on stocks they believe are undervalued and short those they believe are overvalued. This strategy offers the potential to generate alpha in both rising and falling markets. Market-neutral funds seek to maintain a balanced exposure between long and short positions, minimizing market risk and focusing on stock selection to generate returns. Finally, short-selling funds are more aggressive, aiming to profit from declining stock prices by betting against specific companies or sectors.

Equity hedge funds tend to appeal to investors who are looking for stock market exposure but want the added flexibility of hedging risks through short positions or other strategies. However, these funds can carry higher volatility and may not be ideal for those seeking lower-risk investments.

Choosing the Right Hedge Fund Strategy

Selecting the right hedge fund category depends on your specific investment goals, risk tolerance, and market outlook.

If you're looking for broad exposure to global trends, macro and managed futures funds may provide the flexibility and diversification you need.

Event-driven strategies are ideal for investors seeking to capitalize on corporate activity with relatively low correlation to the broader market.

Relative value funds offer a more structured, market-neutral approach with consistent returns, while equity hedge funds provide a mix of traditional stock market exposure with the added ability to hedge risks.

Each category presents distinct advantages and risks, so it’s important to consider how each strategy aligns with your broader portfolio and financial objectives.

At Orgon Bank, we offer personalized guidance and access to a wide array of hedge fund strategies, helping you navigate the complexities of alternative investments with confidence.

Whether you’re looking to diversify with a macro approach, exploit corporate events, or manage market volatility through equity strategies, Orgon Bank has the expertise and resources to match your unique needs with the right hedge fund solution.