Types of Hedge Funds

CHAPTER
2
Types of Hedge Funds
CLASSIFYING HEDGE FUNDS
With thousands of hedge funds in existence, classifying individual funds
into 10 or 20 groups in a challenge. Some funds might fit in more than one
category or none of the categories used to classify hedge funds. Neverthe-
less, fund managers and investors rely on hedge fund classifications.
Importance of Classifications
There are many reasons to categorize hedge funds and group them into
subsets. Investors often study a hedge fund style by reviewing aggregate
performance data, selecting a sector, then reviewing funds within the sector.
The classification makes the average return a meaningful benchmark and
permits the investor to match up with the right fund manager.
To make the classifications meaningful, many investors prefer hedge
funds that fit neatly into a single strategy. Style purity measures how much
a hedge fund keeps to a single, identifiable strategy. The investor preference
for style purity is easy to understand. Suppose an investor researches sev-
eral hedge fund styles and decides that a particular style would be an at-
tractive addition to the investor's existing portfolio of assets. That investor
would be sorely disappointed if the individual fund selected failed to track
the composite.
For a variety of reasons, funds may choose to pursue multiple strate-
gies in a single hedge fund. In some ways, the aggregate performance re-
sembles a fund of funds that gains some benefits from diversification.
Academic writers are often quick to point out that well-healed investors
can accomplish the same diversification (perhaps more efficiently). How-
ever, some investors nevertheless prefer the multistrategy funds, either be-
cause they lack the financial resources to get the maximum benefit from
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