A short definition of hedge funds and the main characteristics have been given in the introduction. Travers (2012) defines hedge funds as "an investment pool that can invest in physical securities and derivatives markets". The most important and unique characteristic of hedge funds is the possibility to employ leverage and short selling, and their aim to generate absolute returns. Different hedge fund strategies use a different approach to reach the aim. The major strategies, as indicated by Credit Suisse's Hedge Index database, will briefly be explained in the following.


2.1.1. Convertible Arbitrage

Convertible arbitrage strategies aim to generate profit on price discrepancies of convertible securities, such as callable bonds. A common way to do so is to build a long position on the convertible security and short the stock or option of the underlying company. The goal, usually, is to hold the number of shares that makes the combined position market neutral. This way it will not fluctuate with the price of the underlying stock and profits are solely based on the price discrepancy.


2.1.2. Emerging Markets

Emerging Markets strategies typically invest in the securities of emerging or developing countries, such as China, India, Latin America, Southeast Asia, parts of Eastern Europe, and parts of Africa. These countries are not yet developed, and managers believe they are able to find arbitrage opportunities in these markets.


2.1.3. Equity Market Neutral

Equity market neutral strategies invest long and short in equities and try to keep their exposure risk neutral (matching long and short for 0 beta). Other methods include keeping the portfolio dollar neutral or factor neutral. This way managers can exploit opportunities in a specific group of stocks, without risk exposure to the broad stock market.


2.1.4. Event Driven

Event driven strategies focus on special events, like mergers and acquisitions, liquidation, bankruptcy or spin-outs. The strategy can be divided into three sub-strategies: Distressed, Multi Strategy, and Risk-Arbitrage.

Distressed managers trade credit securities of below-investment-grade companies. They profit from the high yields of these securities, as they usually trade at discounts. For this strategy it is crucial to investigate all available securities, across a company's capital structure, to identify the best risk/reward potential.

Multi Strategy event driven presents a mixture of event driven equity and credit strategies. Managers aim to take advantage of shifts in economic cycles by investing in different asset classes.

The event driven risk arbitrage strategies want to profit from the changing company value and spreads, related to mergers and acquisitions. The manager will typically buy shares of the company that is announced to be merged, and short sell shares of the corresponding acquirer in order to isolate the spread, while being market neutral.


2.1.5. Fixed Income Arbitrage

Fixed Income Arbitrage Managers aim to generate positive returns by identifying price anomalies in fixed income securities. They build up a long position in an undervalued security, while shorting a related overvalued one. A market neutral or interest rate neutral position could be created to reduce total volatility.


2.1.6. Global Macro

Global Macro strategies attempt to quickly react to changing market dynamics, to profit from the market movements. Managers employ top-down market analysis to exploit global market opportunities, by forecasting effects of political and macroeconomic trends. They go long if they expect bullish markets and short in bearish market conditions. Leverage is often applied to enhance the effect.


2.1.7. Long/Short Equity

In long/short equity strategies, managers try to exploit pricing inefficiencies, by investing long in undervalued equities and short in overvalued equities. The short portfolio can, therefore, be seen as a way to generate more returns or to hedge the long portfolio.


2.1.8. Managed Futures

Managed futures are often referred to as commodity trading advisors (CTAs). Investment decisions are made on global trends and historical price data. Managers can make use of many financial securities, such as equity, commodity futures or currency markets. A high degree of leverage can be applied.


2.1.9. Multi Strategy

Multi Strategy funds have the ability to diversify their capital, over several strategies. This leads to reduced volatility and smoothed returns. Managers aim to generate positive return, independent of directional movements in the markets.