Types of Hedge Funds

diversification or because the multistrategy fund avoids a layer of fees pre-
sent in the fund of funds.
Who Categorizes Hedge Funds?
Many types of organizations label hedge funds according to the style or in-
vestment philosophy they follow. Hedge funds frequently categorize them-
selves in their disclosure documents and marketing literature. Hedge fund
data providers such as Evaluation Associates Capital Markets (EACM),
CSFB Tremont, Hennessee, Hedge Fund Research (HFR), and the Center
for International Securities and Derivatives Markets (CISDM) track thou-
sands of hedge funds and assign most of them to 10 or 15 styles. (Data
from these providers can be used to study the characteristics of the types of
hedge funds discussed here.) A growing industry of hedge fund indexers
begins by creating a benchmark that can be replicated; then the indexers
invest in individual funds to create a portfolio that tracks their bench-
marks. The media often classifies hedge funds, sometimes without regard
to the facts. Finally, analysts and academic researchers may categorize
hedge funds based on their actual performance, explaining returns based
on broad economic factors like interest rates, stock returns, default risk,
volatility, and other factors.
Inconsistency of Hedge Fund Categorizations
Regardless of how and why hedge funds are classified, the results are occa-
sionally inconsistent. Sometimes categories overlap, so the choice of strat-
egy is a bit arbitrary. Sometimes a fund will shift strategies gradually
(called style drift); one data provider might classify the fund by the current
strategy and another might include it in the style previously followed.
Some funds may be tough to categorize because the manager deviates from
the announced strategy. Other funds may follow multiple strategies so
can't fit into a single category. Finally, some funds may be erroneously clas-
sified either because of human error or because there aren't enough cate-
gories to match all hedge funds.
SHARE OF THE MARKET BY STRATEGIES
The changing popularity of individual hedge fund strategies has led to
changes in the composition of the hedge fund universe. Popular strategies
become a large part of the mix of hedge fund assets. Out-of-favor strate-
gies may shrink in size.
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HEDGE FUND COURSE
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