| Although there is no universally accepted definition of | | | | systematic (based upon computer models) or |
| the term hedge fund, the term has evolved over | | | | discretionary (ultimately based on a person). A hedge |
| time to include a multitude of skill-based investment | | | | fund may pursue several strategies at the same |
| strategies with a broad range of risk and return | | | | time, internally allocating its assets proportionately |
| objectives. The common element among these | | | | across different strategies. |
| strategies is the use of investment and risk | | | | Hedge funds are often classified according to |
| management skills to seek positive returns regardless | | | | investment style including following categories: relative |
| of market direction. | | | | value, event-driven, equity hedge funds, global asset |
| Hedge funds are an exciting innovation to the range | | | | allocators and short selling. Within each style |
| of professionally managed investment vehicles that | | | | category, funds are then classified according to the |
| have brought sophisticated investment strategies and | | | | underlying markets traded. For example, within the |
| a new sense of excitement to the investment | | | | relative value style classification, there are a number |
| community. They can serve as an important risk | | | | of sub-groups, including equity market neutral, fixed |
| management tool for investors by providing valuable | | | | income arbitrage, convertible arbitrage, credit |
| portfolio diversification. One might define a hedge | | | | arbitrage and statistical arbitrage. |
| fund as an information-motivated fund that hedges | | | | Various hedge fund return opportunities stem from |
| away all or most sources of risk not related to the | | | | the expanded universe of securities available to trade |
| price-relevant information available for speculation. | | | | and the strategies that can be employed. Funds can |
| Hedge funds use a wide variety of investment styles | | | | access both financial and non-financial (commodity) |
| and strategies. Even among hedge funds that purport | | | | markets and can easily take long, short, spread, and |
| to use the same investment strategy or invest within | | | | option positions in any of these markets. Expanding |
| the same asset class, there is a wide range of | | | | the set of investment opportunities results in |
| investment activities, performance and risk levels. | | | | providing diversification benefits to a portfolio that |
| Because the investment activities of hedge funds are | | | | cannot be replicated through traditional stock, bond, |
| so diverse, the hedge funds assigned to a particular | | | | and real estate investment strategies. |
| investment category are likely to exhibit less similarity | | | | For alternative investments, such as hedge funds, to |
| than more traditional investment vehicles, such as | | | | grow as an investment alternative, individuals need to |
| registered investment companies. | | | | increase their knowledge and comfort level as to |
| The investment strategies are typically designed to | | | | their use in investment portfolios. The logical |
| protect investment principal and engage in a variety | | | | extension of using investment managers with |
| of investment techniques that include fixed income | | | | specialized knowledge of traditional markets to obtain |
| securities, convertible securities, currencies, | | | | maximum return/risk tradeoffs is to add specialized |
| exchange-traded futures, over-the-counter | | | | managers who can obtain the unique returns in |
| derivatives, futures contracts, commodity options | | | | market conditions and types of securities not |
| and other non-securities investments in order to | | | | generally available to traditional asset managers; that |
| generate specific risk-return profiles. | | | | is, hedge funds. In addition, investors must compare |
| Strategies may be designed to be market-neutral | | | | the unique returns available to each of the hedge |
| (very low correlation to the overall market) or | | | | fund styles to insure that the particular style does |
| directional (a "bet" anticipating a specific market | | | | not duplicate existing investment opportunities. |
| movement). Selection decisions may be purely | | | | |