Hedge funds are an unregulated private pool of investment vehicles, usually supervised by professional investment management companies with limited liability. They do not necessarily stick to any one investing philosophy.

Hedge funds use leverage (borrowing money or securities) featuring long-term and short-term positions. They can invest in small asset classes and are free to change investments at anytime.

Hedge Fund Strategies

Hedge funds call on varying strategies that result in strong returns for investors. Some hedge funds even utilize more than one strategy at a time—a multiple-strategy approach.

Hedge Fund Groups

Long/Short Equity
Some hedge funds that follow a long-term/short-term equity formula work on buying and selling the right stocks. Other funds concentrate on the direction of the market, going from market short to market long.
Result: Moderate to Very High Risk with Moderate to Very High Returns

Equity Arbitrage
Hedge funds that focus on equity arbitrage buy or sell a specific amount of every stock in a particular index then trade on futures.
Result: Moderate Risk with Moderate Return

Equity Pairs Trading
With this strategy, hedge funds buy and sell the shares of two comparable companies or similar equities from the same company.
Result: Low-Risk with Strong Returns

Equity Market-Neutral Funds
These hedge funds mix issues from a specific country into complementary long and short portfolios. Trading usually revolves around one major investing theory.
Result: Strong Returns

Risk Arbitrage/Merger Arbitrage
Hedge funds buy stocks in a company when a takeover is imminent. Performance varies in this category since fund managers take different approaches to dealing with the risk the takeover may not happen and the deal will not be profitable.
Result: Strong Returns

Event-Driven Strategies
Risk arbitrage is sometimes considered part of a category known as event-driven strategies. These strategies usually draw on corporate events such as mergers, acquisitions, divestments, liquidations, bankruptcies, and reorganizations. Each strategy depends on research to set up deals rapidly.
Result: Fairly High Returns

Convertible Bonds
These hedge funds buy convertible bonds or convertible preferred stocks that feature debt, equity, and options characteristics.
Result: Low Risk

Fixed-Income Arbitrage
Several hedge funds make huge bets on a combination of risks. These are called fixed-income arbitrage funds. They use foreign equities and forward currency exchange rates to trade between the cash and futures markets, credit and default strategies, yield curve strategies, and synthetic money market vehicles.
Result: Low Risk and Low Returns

Mortgage Arbitrage
Often considered part of fixed-income arbitrage funds, mortgage hedge funds deal with mortgage-backed bonds. Freddie Mac, Fannie Mae and the Home Loan Bank transfer mortgages into pass-through securities which are then transformed into collateralized mortgage obligations (CMOs) and real estate mortgage investment conduits (REMICs).
Result: Low Risk and Low Returns

Emerging Markets
The securities of smaller, less developed countries are the focus of hedge funds that concentrate on emerging markets. These investments are generally considered quite unpredictable due to economic and political factors. Hedge funds can work with equities or fixed-income or both.
Result: High Risk

Distressed Securities
Hedge funds in this arena purchase stocks or bonds of companies that have either filed bankruptcy or are extremely close to doing so. Funds usually get securities at huge discounts and sometimes hold onto them for a number of years.
Result: Low Risk and Fairly High Returns

Global Macro Funds
Global macro funds invest in stocks, bonds, commodities, and currencies with an eye on broad economic factors, particularly overseas happenings. These funds are considered some of the most unstable.
Result: High Returns