Two funds both call themselves "long/short equity." One runs 85% long against 25% short; the other runs balanced books with zero net beta and four turns of leverage. They are not the same product, and the exam expects you to know which one belongs in a stressed portfolio.
Seven characteristics separate hedge funds from regulated funds: lower legal and regulatory constraints, flexible mandates permitting shorting and derivatives, a larger investment universe, aggressive investment styles with concentrated positions, liberal use of leverage, liquidity constraints (lock-ups, gates, exit windows), and high fees (roughly 1%+ management plus 10% to 20% incentive).
Liquid alternatives (liquid alts) are mutual fund, closed-end fund, Undertakings for Collective Investment in Transferable Securities (UCITS), and ETF vehicles running hedge-fund-like strategies. They offer daily liquidity, transparency, and lower fees, and generally cannot charge an incentive fee. Empirically they underperform comparable private-placement hedge funds by roughly 100 bps to 200 bps per year, consistent with an illiquidity premium that a daily-liquidity wrapper cannot carry.
Common mistakes
- Calling EMN low-risk because beta is zero. Neutralized beta forces high leverage, and quantitative pairs books carry short-volatility tail risk in dislocations.
- Reversing convertible arbitrage exposures. The book is roughly 300% long convertibles against 200% short equity, not balanced; the gap is delta adjustment, not a directional bet.
- Treating merger arbitrage as riskless carry. The profile is insurance-like plus a short put; Example 2's break costs 19.15% unlevered against a 6.38% gain.
Bottom line
- Six categories: equity, event-driven, relative value, opportunistic, specialist, multi-manager; classification runs on instruments, philosophy, and risk type
- Long/short equity: 70% to 90% long vs 20% to 50% short, 40% to 60% net long, long-only returns at half the volatility
- Short sellers: dedicated 60% to 120% short, short-biased 30% to 60% net short, low leverage, negatively correlated but lumpy returns
- Equity market neutral: near-zero beta, quantitative, high leverage, mean-reversion driven; pairs, stub, and multi-class trading
Exam shortcut
Read the exposure numbers first, they name the strategy before the prose does. Net 40% to 60% long is long/short equity; 30% to 60% net short is short-biased; zero beta with 4× leverage is EMN; 300/200 is convertible arbitrage. When a stem stresses "steady returns punctuated by sharp losses," answer merger arbitrage and say short put. When it stresses crisis-period diversification with right-tail skew, answer managed futures.
The full lesson (about 2,972 words, 20 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- hedge fund strategies
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