Types of Hedge Funds

and a bit too inclusive, the equity arbitrage group includes funds that trade
definable, tradable relationships between securities.
When data vendors provide a separate breakdown of equity arbitrage
from other equity market neutral strategies, the arbitrage group provides
higher returns and somewhat higher risk (as measured by the standard de-
viation of returns). The high risk and return is probably attributable to the
higher leverage in the arbitrage funds compared to other equity market
neutral strategies. As a portfolio investment, this higher risk may be forgiv-
able because the volatility remains well below traditional stock returns. In
addition, the performance of the equity arbitrage funds is less correlated to
stock returns (about 25 percent) than any other equity hedge fund strategy.
Long/Short Equity
Generally, this category includes hedge funds that may
be either long or short.
2
In particular, the funds can be levered long (proba-
bly no more than 2 to 1), market neutral, or modestly short. Performance
depends both on stock selection and market timing.
The performance of this group depends on the data source. The group
of long/short hedge funds tracked by both CSFB Tremont and CISDM be-
tween January 1, 1990, and December 31, 2003, had higher returns than
the S&P 500 index while the data from EACM reported returns only half
the level of the S&P 500 return. Although differences are common between
data providers, this discrepancy is untypically large. The hedge fund group
was a bit more consistent over time than the S&P (as might be expected
from a group of nondirectional investors) so the differences depend more
on the return of the index than the returns in the group. The returns for
long/short hedge funds can be rather volatile, although usually less than an
investment in a market portfolio of common stocks such as the S&P 500
index. The correlation of the long/short group to stock returns ranges from
very high to very low across different data vendors, although the correla-
tion has been low recently.
Event Driven
The event driven category includes several strategies often
tracked separately. This group includes hedge funds involved with risk ar-
bitrage (also called merger arbitrage), bankruptcy and reorganization (and
other high-yield variations), spin-offs, and Regulation D funds. The cate-
gory includes funds that invest purely in one of these strategies and multi-
strategy funds that may pursue several of the strategies.
The individual event driven strategies (risk arbitrage and Regulation D
funds) are described separately. As a group, the strategies provide returns
and risk typical of hedge funds. That is, they provide returns about equal
to stock returns (more or less depending on the particular strategy) and
substantially less risk than stock returns (about median among hedge fund
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