The Ever Changing Landscape of Hedge Fund Strategies

What investment strategy constitutes a Hedge Fund?  For many years this question had a relatively easy answer and most likely that answer was long/short equity approach.  As the Hedge Fund industry matures the answer continues to expand and includes convertible arbitrage, fixed income arbitrage, pairs trading, statistical arbitrage, event driven, distressed, global macro, black box trading and more. Some may say that any investment strategy where you are able to have an investor pay at least 2% management fee and 20% performance fee is a Hedge Fund strategy and there is probably a lot of truth to this comment.

As the industry has expanded the appetite from accredited investors has grown and the investors have asked the funds to identify new investment strategies that produce alpha as well as performance uncorrelated to the equity markets.  This drive to fulfill the investors’ appetites has led large multi strategy hedge funds to expand their product line ups and the emergence of managers with niche focused strategies. Furthermore, as smart fund managers have found new arbitrage opportunity in the ever changing market, they too have created new strategies.

Almost every financial news outlet has written about the firm’s expanding their product line ups.  The articles have addressed the addition of numerous strategies to the bigger fund line ups including the addition of long/short sector focused funds and real estate/mortgage based strategies to name a few. The articles have discussed how most of the large Hedge Funds now have Private Equity groups and even how many Private Equity groups are now entering into the Hedge Fund space.  The fusion of the two strategies has caused alarm with some investors and regulators while others are excited by opportunity of this merger.  On the flip side, a few firms have started to take the other approach and their Private Equity groups have split from the larger Hedge Fund group such as was the case with Pequot Capital.  This concept is still very new and exactly why it happens no one is 100% sure, I would guess the issue is at least partly an ownership issue.

These large multi-strategy firms have for the most part added strategies that have already proven successful by many other funds such as a convertible arbitrage shop adding statistical arbitrage to their fund’s line up. The more interesting and creative strategies have been started as niche firms. These strategies typically are harder to market and receive increased scrutiny from investors but they usually follow the main principal of creating returns which are uncorrelated to the equity markets.  

Probably one of the most famous of these strategies is International Equine Acquisitions Holdings, the owner of this year’s Kentucky derby winner Big Brown. IEAH is currently in the process of becoming a $100 million dollar Hedge Fund which will invest in and breed race horses.  Another famous fund from a few years ago was the Hedge Fund focused on Sports Betting that Mark Cuban, the owner of the Dallas Mavericks, wanted to create.  We have also heard about funds which focus on Legal Litigation--the biggest we believe is based in London. Two other strategies which are gaining immense popularity are funds focused on trading carbon credits or water rights.  

These new strategies bring with them a wide range of issues from basic due diligence questions to questions/issues regarding collateral, valuation and custody of the products that these strategies use as the basis of their investment hypothesis. These issues will need to be addressed by the funds potential clients, administrators, accountants and other service providers. I am sure if and when these strategies grow in popularity their will become a set of standards for each of these strategies. At some point benchmarks will be created so investors can compare funds to others in the same strategy.  In the mean time, with these new strategies comes new employment opportunities for individuals who are either specialists in a specific field or are interested in using their financial modeling skills on a new or yet unproven investment hypothesis.

We have only named a few of the new more unique niche investment strategies in this article. If you would be open to sharing some more strategies we would be very interested in hearing about them.  There are always new and interesting strategies in development. I am aware of a few which I cannot discuss at present but look for them in future newsletters or on my daily blog.