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• Global Funds, which also take positions worldwide, but employ bottom-up analysis, picking stocks on the basis of individual companies' prospects.

• Relative Value Funds, which take bets on the relative prices of closely related securities (treasury bills and bonds, for example). They limit their holdings to the mature markets, because their expertise is limited to those markets. Relative value funds are also inclined to use derivatives.

However, these are not rigid watertight differentiations, hedge funds have undergone a sea change. Those hedge funds that survived and new entrants experienced resurgence in the 1980s associated with global financial liberalization that opened new investment opportunities. "Macro" funds increasingly departed from the traditional hedge fund strategies that had focused on stock picking to take positions on the overall direction of broad global shifts in stock markets, currencies, and interest rates. Managers built internationally diversified portfolios of government bonds, currencies and other assets. Global funds reaped huge benefit on account of "global macro play" involving a large investment in foreign currency call options purchased in the expectation that the US dollar, having risen sharply for four years, would decline against the European currencies and the yen. Subsequent years saw the establishment of hundreds of new hedge funds following a variety of investment strategies, most of which utilized short sales, leverage, and derivative instruments even more specialized than currency call options.

History of Hedge Funds

A "hedge" in the financial world is a transaction that reduces the risk of an investment. In 1949, A. W. Jones established in the United States what is regarded as the first hedge fund. Jones combined two investment tools - short selling and leverage. Short selling involves borrowing a security and selling it in anticipation of being able to repurchase it at a lower price in the market, at or before the time when it must be repaid to the lender. Leverage is the practice of using borrowed funds. (Financially leveraged firms, thus, have high debt-to-equity ratios.)

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* Contributed by -
Swetha Narayanaswamy,
M.B.A. II year (Finance),
ICFAI Business School, Mumbai.