An Introduction to Hedge Funds

By Daisy King – Analyst for Mercer’s Funds of Hedge Funds

 What are hedge funds & how do they work?

A hedge fund is a type of asset manager. It’s a pool of money (a fund), managed by a team of professional investors (the hedge fund manager, also known as the portfolio manager).

One of the reasons a hedge fund is different to a pure equity (stock) or fixed income (bond) fund, is that it is unconstrained. “Unconstrained” is an industry term that basically means hedge fund managers have flexibility to invest in different types of assets and do it in ways that traditional funds aren’t able to.

As a group, hedge funds are hard to define, because by their nature they are trying to do something different to other funds and find unique investment opportunities. The easiest way to explain hedge funds is to go through a few examples of common hedge fund styles:

Example 1) Long/short equity hedge funds will buy stocks in companies that they expect will increase in value and sell short stocks that they expect to decrease in value. If a hedge fund manager “shorts” a stock, they will make money if that stock price falls.

Example 2) Activist hedge funds aim to identify mismanaged companies and attempt to secure a majority shareholder stake so they can be actively involved in the company’s management. This allows them to have an influence on driving improvements in the company’s efficiency to enhance the company’s prospects and value.

Example 3) Macro hedge funds have the ability to trade across all major asset classes i.e. global bond, equity, currency, and commodity markets, and can make both directional or relative value trades. “Directional” trades make an investment based on the hedge fund manager’s view of whether a market will rise or fall, for example, a view oil markets will rise over the next 12 months. “Relative Value” trades make an investment based on a view of whether one market or asset will outperform another in relative terms, for example, Chinese equity markets will rise by more than US equity markets will rise over the next six months.

What’s your role?

I work in a team at Mercer that manage funds of hedge funds. On a day to day basis, our team focuses on assessing hedge fund managers to find those that have above average prospects of outperforming. We then build portfolios of highly rated managers for Mercer clients based around their requirements.

What training/qualifications do you need to work in the industry?

I have completed the Investment Management Certification “IMC”, and the Chartered Financial Analyst “CFA” and Chartered Alternative Investment Analyst “CAIA” designations.

Overall, the hedge fund industry is full of people from diverse professional backgrounds - all experts in what they do - from academics and quantitative modelers to accountants, behavioral finance and   legal experts.

What do you enjoy the most about working in the hedge fund industry?

I love being in an industry that is on the forefront of innovative investment ideas. There is a vast level of research in the hedge fund industry focused on challenging norms to find fresh opportunities for investments. For example, how to use AI to enhance investment decision making. It’s exciting to be part of these conversations.

What core skills do you need to do your job?

·       Be inquisitive - A desire to learn every day is essential. Things are always changing in investment markets, so you need to keep pace!

·       Have an analytical way of thinking - Roles in the hedge fund industry vary in the level of mathematical skill required for the job, but it goes without saying that across all jobs an analytical way of thinking is important to be able to digest complex concepts.

·       Put numbers in context - It’s not all about maths though! Having the skills and knowledge to put the investment analysis in the context of both theory and real world events is crucial.

What advice do you have for young women interested in getting into the industry?

My top piece of advice for anyone looking to get into the industry; find something that sparks your interest. Using a learning avenue that works for you, maybe a podcast series, YouTube or news website, start learning about the investment industry and reading about current financial events. Once something sparks your interest, dig deeper into that area. You’ll stand out at interviews and end up in a job that’s right for you if you find an area of the industry and a topic that interests you, genuinely, and that you can talk passionately about, rather than blagging your way through.