Hedge Fund

mental techniques focus on objective financial results, valuation, and com-
parisons between assets. In contrast, technical analysis relies mostly on the
pattern of prices, interest rates, or exchange rates over time. The descriptions
that follow describe neither fundamental nor technical analysis.
Like traditional asset managers, hedge funds may be organized as top-
down or bottom-up investors. A top-down investment organization begins
by making macroeconomic forecasts, then makes forecasts for returns on
broad classes of assets. Next, the firm makes asset allocation decisions
among stocks, bonds, currencies, commodities, and other assets. Next, the
firm develops valuation opinions for individual assets within the asset
groups consistent with the macroeconomic assumptions and broad asset
expectations. Finally, the firm makes allocations to individual assets, con-
sistent with portfolio considerations. Bottom-up investment organizations
begin by valuing individual assets. Opinions on sectors and asset groups re-
flect these valuations. Assets are then allocated to asset groups and then
into individual positions.
Long/Short Equity
As mentioned in Chapter 2, a long/short equity hedge fund may be long or
short. Typically, this type of fund will carry both long and short positions,
but the sizes of the positions can vary to profit from either rising or declin-
ing prices of stock.
A long/short equity hedge fund may commit to net long or net short
equity exposure based on either fundamental or technical analysis. A firm
may develop a fundamental valuation opinion from either top-down or
bottom-up methods. The fund will carry an overweighting in long or short
positions but maintain offsetting positions in individual stocks, often con-
centrated in a few narrow sectors. Frequently, the long/short hedge fund
will carry net equity exposure based on technical models. Finally, a fund
may make the long/short decision based on a combination of factors and
trader discretion.
The hedge fund will also pick sectors and individual stocks based on
either fundamental or technical valuation. For example, a fund may
value a large number of stocks and carry long positions in a subset of
stocks that are undervalued and short positions in a subset of stocks that
are overvalued.
Event Driven--Merger Arbitrage
Hedge funds that invest based on a variety of events that can affect corpo-
rate control of a firm are called event driven hedge funds. Event driven
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