Hedge Fund Strategy Classification: My Perspective

A common topic of discussion in hedge fund circles is how strategies are related and should be grouped or classified. Putting strategies into broader groupings may be useful to the risk management effort. Of course, one can argue about how coarse or fine the strategies should be.

On one hand, one could argue all manager's strategies are unique (thus making any classification meaningless) or one could group it in only two or three categories. In the Handbook of Alternative Investments, Mark Anson classifies strategies into three groups: strategies taking market risk, strategies taking credit risk, and those taking low market and credit risk.

Under market risk focused, Anson lists Equity long/short, short selling and Global Macro. Under Credit Risk, he lists convertible arbitrage, event driven, merger arbitrage, fixed income, and relative value. Under low market and credit risk, he lists market neutral and market timing.

We had occassion to independently classify twenty-two strategy indices into meaningful categories and we came up with six (including managed futures). Since managed futures is technically not a hedge fund strategy, it is not part of Anson's hedge fund classification scheme. Our classification used a factor analysis that we performed on approximately 10 years of data for two providers: CSFB/Tremont and Evaluation Associates.

Our Market Neutral category has only one index, the Evaluation Associates Market Neutral index.

Our Equity category includes Equity Long/Short (except for Emerging Markets and Equity Global) and Short Sellers. It excludes Global Macro.

Our Global classification includes Equity Global, Emerging Markets, and Evaluation Associates Discretionary.

Our Relative Value category includes Convertible and Fixed Income Arbitrage and Relative Value Multi-Strategy.

Our Event Driven category includes Merger Arbitrage and Distressed, as well as Emerging Markets, and Event Driven Multi-Strategy.

Relative Value and Event Driven shold not be lumped together, as they have very different correlation to the second factor.

Our Managed Futures category has Managed Futures and Systematic indices

Finally, two indices did not fit well in our clasification scheme: CSFB Tremont Global Macro and the CSFB/Tremont Equity Market Neutral index. Both have too much exposure to the first directional factor.

In summary, our chief disagreements with the Anson classification scheme are the placement of Global Macro in the market risk category and the failure to distinguish between relative value and event driven strategies.