1. Hedge Funds and their strategies
Bus 9443

2. Hedge Funds
These are currently major players in world financial markets
Claim to give attractive risk-adjusted returns and/or positive returns in both up and down markets
Attractive to managers because of rich fee structure
Investors typically “sophisticated” and willing to tie up money for long periods

3. Main Categories of Hedge Funds
Macro Funds (Julian Robertson, George Soros)
Quant Funds
Market Neutral Funds

4. Macro Funds Make “big picture” bets on economic trends
Often active in Forex Markets
Classic example: Soros (Quantum) betting against the GBP and breaking the European Exchange Rate Mechanism in the mid 1990s
Sector rotation strategy also popular here.

5. Quant Funds
Large numbers of strategies based on quantitative drivers often involving options:
Long/Short
Yen Carry
Covered Calls
Index Change
Convertible Bond
Long Corporate Bond Short Stock
Merger Arbitrage

6. Long/Short More of a fundamental trade but with quantitative aspects
Eg. Have no opinion on Cdn banking sector but you think BMO is cheap relative to the bank index and RY is rich. Then Long BMO short RY
Can set up dollar neutral or according to some fundamental gearing

7. Yen Carry
In a way this is a macro trade but it’s also very popular with quant funds
Idea is to borrow money in Yen (at a low interest rate) and to lend it in Dollars or Euros (at a higher rate).
Historically this has been “the gift that gives twice” as the Yen/Dollar FX rate has moved against the Yen.

8. Covered Calls
“Volatility” is often overpriced relative to historical data.
This is because going short vol is very risky relative to being long vol.
Covered call strategy is a good way to monetize this.

9. Index Change
Stock Indices have prescribed members (eg S&P 500 has 500 stocks etc)
Companies in the index can disappear
In this case a new company must join
Index funds and closet index funds must then buy the company pushing it up.
Good link with Merger Arb strategy

10. Convertible Arb
Convertible bond is a corporate bond which, in addition, may be converted into company stock at a pre-set ratio within a pre-set time window.
Therefore kind of like “bond + option”
Buy convert, short stock, short govt bonds.
Danger here: credit risk

11. Long bond short stock
Idea here: As company comes close to being bankrupt stock price falls.
So why not buy the debt of the company and short the stock?
Problem here is what happens if the company does really well.

12. Merger Arbitrage
Topic of next lecture