Hedge funds strategies can broadly be characterized into directional and nondirectional ones. A directional strategy implies a bet anticipating a specific movement of a particular market, while a nondirectional strategy can be considered market-neutral. this means that nondirectional strategies have very little correlation with broad market indexes.
Many hedge funds employ nondirectional strategies by going long in certain instruments and simultaneously short in others with the result that net exposure to overall market movements (e.g., a stock index, style factors, industry factors, exchange rates, interest rates) is close to zero. Broad classes of nondirectional strategies are long/short, arbitrage and relative value, and event driven strategies (e.g., merger arbitrage).
Long/short strategies aim to identify undervalued and overvalued securities to set up a combined long and short position. long/short portfolios are rarely completely market-neutral and often exhibit either a short or a long bias.
Arbitrage and relative value strategies typically involve a perceived mispricing of related financial instruments. For example, convertible arbitrage involves a long position in convertible bonds combined with a short position in the underlying stock or bond.
While event-driven strategies are often categorized separately from market-neutral strategies, they typically involve little exposure to general market movements. The most popular event-driven strategies relate to investing in distressed securities and to merger arbitrage.