There are indices representing only one particular strategy (e.g., convertible arbitrage). In contrast, a global hedge fund index consists of a combination of selected strategies. These strategies can, forexample,beassetweighted.
This weighting scheme automatically reacts to changes in the composition of the hedge fund industry because the different investment strategies are weighted according to the distribution of assets in the overall hedge fund universe. Such a dynamic weighting scheme would be an alternative to an equalweighted strategies scheme.
Another alternative weighting scheme equally weights each fund to avoid that only a small number of large funds have the most significant impact on the index. In contrast, usually by weighting the investment strategies according to the number of funds in each strategy, a global hedge fund index is constructed.
Then, the strategies included in a global hedge fund index can generally be classified into
- relative value strategies,
- event-driven strategies, and
- opportunistic strategies.
Relative Value Strategies
Relative value strategies (or market neutral strategies)aimatexploitingpricedifferences between different investment instruments, whose prices are related to some underlying economic relation.
The strategies are based on the assumption that over a long-time horizon prices tend to move toward their intrinsic values. Once misvaluations in asset prices have been corrected over time, asset prices converge back to an equilibrium state.
At the same time, the different kinds of risk (such as market, sector, or interest rate risks) should be eliminated. This means that, for example, the beta or duration of the overall investment portfolio is approximately zero.
Relative value strategy types are equity market neutral, fixed income arbitrage, and convertible arbitrage strategies. For a description of the different strategies, see e.g. Hedge Fund Research Inc. (2007a), Credit Suisse Tremont Index LLC (2007) or AIMA and ASSIRT (2007).
These strategies are based on the observation that certain events may result in a new valuation of companies and, hence, there will be a corresponding change in prices given such events.
Possible events might be mergers and acquisitions, spin-offs and carve-outs, financial decisions like initial public offerings, capital increases, or share repurchases as well as restructuring activities. Such events may particularly affect the prices of corporate stocks and bonds. Typical strategies include merger arbitrage or distressed securities strategies.
These strategies are based on the assumption that some market participants have better forecast abilities than others and, hence, there is a situation of information asymmetry. Opportunistic strategies include global macro, long short equity or equity hedge i.e., long short equity, equity hedge, short selling, and emerging markets strategies.
Concentrating on securities in emerging markets, an emerging markets strategy aims at earning abnormal returns by exploiting inefficiencies in the valuation of equity and fixed income securities in lessdeveloped regions.
An example of a global hedge fund index is the Greenwich Global Hedge Fund Index, see Greenwich Alternative Investments Research Inc. (2006). This index consists of 13 different types of strategies.
Another example is the HFRX Global Hedge Fund Index that includes strategies such as convertible arbitrage, distressed securities, equity hedge, and equity market neutral strategies. The dynamic weighting of these strategies, that is, asset weighting, allows for a representation of the overall hedge fund universe.
|Global Hedge Fund Index|