Types of Hedge Funds

strategically and invests in fixed income markets only incidentally or as
part of an arbitrage strategy. The group contains arbitrage traders that
produce low returns but take little risk. The group also contains funds that
take strategic positions in a variety of currencies (not necessarily hedged
and generally not part of arbitrage positions). This second group is an ex-
ample of a "portable alpha strategy." A portable alpha strategy is an in-
vestment strategy, possibly part of a traditional, long-only portfolio
strategy that has favorable performance and can be recast as a strategy
that: (1) is extracted from the traditional portfolio and (2) could be added
to any type of portfolio to improve the return on the portfolio. These
traders have adapted trading styles from other types of investment vehicles
to create a nondirectional investment strategy.
Funds of Funds
Funds of hedge funds invest in other hedge funds. On the surface, this
seems redundant and the investor might hesitate to pay fees to a fund of
funds manager on top of the fees paid to the managers directly managing
the funds.
Funds of hedge funds have several advantages to both large institu-
tional investors and investors with considerably less sophistication and
with smaller portfolios. First, the minimum investment is often smaller
for a fund of funds than for a hedge fund. Second, the fund of funds in-
vests in many funds, so the investor gets some risk reduction from diver-
sification, especially for investors who have limited resources to invest in
hedge fund assets. Third, the fund of funds may negotiate a reduction on
fees so an investor may not pay significantly higher fees investing
through a fund of funds intermediary. Fourth, the fund of funds man-
ager may have access to information about funds and may perform
analysis of funds that improves return or reduces risk. Fifth, the fund of
funds manager may be able to invest in funds otherwise closed to new
investment because of agreements made to get preferential access to
hedge fund capacity.
SUMMARY AND CONCLUSION
It is impossible to classify 8,100 hedge funds into a dozen categories. The
strategies or styles described in this chapter include the largest categories.
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