Masters of Risk: Hedge Funds Uncovered
Intro
Hedge Funds, the talk of the modern financial scene. In this post, we will unpack what Hedge Funds are, what strategies they employ, and how they can affect the economy and private investors.
General Information
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Hedge funds are private investment institutions that invest capital from high-net-worth clients across many asset classes to generate profits. The goal of a hedge fund is to generate high returns for high-income clients through aggressive investment strategies, while also highly compensating the fund's managers. Managers of the Hedge Fund can be compensated in accordance with the 2 and 20 rule, meaning they receive 2% of assets under management and 20% of profits. Hedge funds influence the economy by setting a standard for risk management for investors seeking to balance “hedging” against risks and generate high returns. In addition, Hedge funds are less regulated than other financial institutions, enabling them to pursue high returns, but also contributing to volatility in the economy as a whole.
Strategies that Hedge Funds employ- Equity Long/Short
This strategy is implemented by Hedge Funds investing heavily (long) in undervalued stocks (stock prices are below the “true” value of the company) and shorting overvalued stocks (stock prices are above the company’s value). This strategy is implemented significantly during times of uncertainty or volatility, when companies are overvalued or undervalued, at the end of quarters (earnings reports), or when Fed policy is uncertain. In addition, the purpose of this strategy is to make a profit when undervalued stocks rise and overvalued stocks decline, with appropriate risk management to avoid over- or underestimating market direction. Also, some hedge funds, such as Michael Burry’s Scion Asset Management (shut down in November 2025), focused heavily on shorting stocks.
Strategies that Hedge Funds employ- Global Macro
This strategy is implemented by investing heavily in economic trends of the whole economy (macro view), such as bonds, commodities, and currencies. This strategy is implemented significantly during times of shifts in macro policy, such as changes in Fed policy or geopolitical conflicts (e.g., wars), utilizing discretionary (human judgment) or systematic (quantitative analysis) strategies to implement global macro accordingly. An example of implementation would be shorting a stock in preparation for a Fed Rate increase, being ready for an economic slowdown, and the decrease in the company’s value. The purpose of this strategy is to capitalize on uncertainty and shifts in global sentiment and profit from the indecisiveness and fear of others during times of change for global economics and macro policy.
Strategies that Hedge Funds employ- Event Driven
This strategy is implemented by investing in equities based on corporate events. To understand this strategy, we will look at one of the most successful and widespread Event-Driven strategies: the Merger Arbitrage strategy. The Merger Arbitrage strategy involves purchasing shares of the target company (the company being acquired by another company) and shorting shares of the acquiring company (the company gaining control of the target company in a Merger and Acquisition deal). Due to uncertainty in share pricing, Hedge Funds are buy shares lower(target company), and short shares before they lose value(acquiring company), in order to capitalize on the fears of the acquiring company’s balance sheet taking a hit with the acquisition (making money off the short), and the positive impact the premium offered by the acquisition to the target company (making money off buying the stock). The Event-Driven strategy as a whole is implemented during corporate events/change (such as mergers and acquisitions), and is motivated by shifts in corporate market sentiment.
How do Hedge Funds affect the economy as a whole, and how can you capitalize on their investment strategies?
Hedge Funds set precedent in corporate finance, markets, and monetary policy by shaping market trends through their investing. By managing risk and profit, Hedge Funds aim to exploit market inefficiencies and lapses in other investors' judgment, establishing lucrative market trends that influence many different institutions and functions of the economy. Also, as shown in the chart, the correlation between Hedge Fund actions and the overall stock market/economy is undeniable. By introducing and establishing these lucrative strategies, private and individual investors, such as you and me, can use them to their own advantage, boosting the profits they earn.
Conclusion
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