Guide To Quantitative Hedge Fund Types

Hedge funds are often seen as the top institutions of the financial world. For decades, these funds have provided financial services to the elite, earning them millions of dollars in profits through high-risk strategies and top-of-the-line financial structures. This has led many investors to idealize the hedge fund as the goal of your investment journey, but is this destination worth the effort made to get there?

This comprehensive guide to quantitative hedge fund types includes their fee structures, strategies, and risk mitigation tools to keep these financial institutions running.

Quantitative Hedge Fund Types

Regardless of their overall structure, hedge funds take one of several variations on their internal structure. The internal structure of a hedge fund greatly determines how profits are utilized and how resources are managed to the benefit of its clients. The major variations of hedge fund account types include:

The type of account a given hedge fund utilizes greatly affects liquidity, tax exemptions, and liability for potential and existing clients. A commingled fund, for example, hands much of the control over to the hedge fund manager, freeing them up to move their investments around quickly without having to get investor approval. This is less true in a listed fund, in which public knowledge of the fund’s portfolio prevents managers from doing this, lest they risk future investments by compromising their transparency.

Quantitative Hedge Fund Structures

Hedge funds exist at the top of the financial investment world, however, this does not mean that their overall makeup is uniform in nature. In fact, there are three distinct types of hedge funds, which utilize a number of different fee structures, strategies, and account types. These include:

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It’s important to remember that not everyone has the same values you do, so keep that in mind as you scan the ESG landscape. Much in the same sense that SRI investing requires investors to be aware of their initial decisions, it similarly requires them to keep up with those investments should the public mindset change. 

In this sense, investors should be prepared to keep close tabs on these companies (and the shifting public perception of them) to make the proper adjustments to their investment strategy moving forward and be wary of platforms that encourage a more “hands-off” approach.

A man stacks coins on a desk.

Quantitative Hedge Fund Types by Fees

Traditionally, the standard fee structure with hedge funds has been the “2 and 20” model, which is comprised of:

The performance fee charged by hedge funds is not universally applied regardless of profit, however. To earn this bonus, funds have to clear a hurdle rate, a minimum rate of return that the fund needs to generate before it can charge the performance fee. This hurdle rate is also known as a benchmark, and some funds benchmark themselves against an index. For example, the S&P 500 index is commonly used as a hurdle rate. If you beat the S&P, usually you are beating the market, but again this depends on the investment approach of the manager.

The rise of quantitative investing, however, has changed this structure somewhat. By breaking through the barriers that once made a successful investment strategy an exclusive privilege, AI investing has done a remarkably good job at drawing

in large swaths of investors. This has led some larger funds to consider whether the “2 and 20” model is deserving of revision.

Hedge Fund Strategy

Hedge funds exist at the top of the financial investment world, however, this does not mean that their overall makeup is uniform in nature. In fact, there are three distinct types of hedge funds, which utilize a number of different fee structures, strategies, and account types. These include:

A man moving a chess piece.
The traditional model has been the mainstay of hedge fund strategy approaches since their inception, however, the introduction of artificial intelligence and algorithmically powered investment strategies into the financial sector over the last decade is causing something of a shift amongst hedge funds. They are increasingly turning to a quantitative model, in part because quantitative approaches relieve the need for labor by doing the job of several financial advisors. It is also because a quantitative approach can be applied toward one or several investment strategies.  
Strategy Description Example
Long The fund invests pooled money into a stock it believes will gap up to generate a profit. Investing $300 in Microsoft with the expectation that the stock will increase in value.
Short The fund sells borrowed stocks with the intent to buy them back at a lower price for a profit. Borrowing and selling $300 of Microsoft stock and buying the stock back at $200 after it drops, earning a $100 profit, minus borrowers fees.
Arbitrage The fund immediately buys a stock in one market and sells it in another one to take advantage of small price differences between the two. Buying Microsoft stock at $300 a share on the NYSE and selling it at $305 on the LSE, earning a $5 profit.
Global Event  The fund buys or sells stocks depending on how it believes they will be affected by global events. Investing in toilet paper in response to a natural disaster (flood, hurricane, pandemic, etc.)
Each of these strategies carries its own level of risk. Shorting stocks, for example, is a notoriously high-risk strategy, since the investor will end up owing significantly more than they initially borrowed should the stock rise in price instead of decrease as expected. Going long on a stock, on the other hand, is a significantly lower risk since the investor can never lose anything more than their initial investment. Arbitrage and global event-driven strategies carry a higher degree of risk since the prices on markets are known to shift quite rapidly. Although this risk is inherent to any approach, it is worth pointing out that quantitative investment approaches somewhat mitigate risk. AIs are very effective at calculating the shifting tendencies of markets offering what is often a more complete analysis than a financial advisor might be able to give you. They are not perfect, of course—AIs are excellent predictors of market trends but deal poorly with new stimuli for which they do not yet have an algorithm programmed. It is for this reason that quants are in such high demand in quantitative hedge funds.

Hedge Fund Risk

The element of risk is present in any investment strategy or approach, however, hedge funds have developed a reputation over many decades as being particularly focused on high-risk, high-reward strategies. This is how they’ve earned their reputation for maximizing profits for super-wealthy investors, but in many cases, hedge funds are prone to making mistakes and losing millions or even billions.

For this reason, hedge funds focus on liquidity—assets that are similar to cash or can be converted quickly and easily into cash. Examples of liquid assets would include cash, treasury bonds, and even some stocks. Focusing on liquidity allows hedge funds to quickly switch between strategies and react to unpredicted market events. Keeping that ability to easily pivot between strategies allows hedge funds to hedge their bets when the initial investment strategy does not work as predicted.

Hedge funds also emphasize restrictions for their investors to make sure that funds are securely locked up where the fund can use them. Examples of this include:

Having these mechanisms in place ensures that the hedge fund has the necessary pooled resources to conduct its investment strategy and prevents investors from backing out prematurely.

Is a Hedge Fund Right for You?

Another aspect of quantitative hedge fund types is the expense involved in starting with one. Hedge funds are able to engage in high-risk strategies with investor money by limiting their membership only to accredited investors—individuals with a net worth of at least $1 million and an annual income of $200,000. In addition, the buy-in for most hedge fund services ranges anywhere between $100,000 to several million. For this reason, hedge fund services of any approach strategy or structure are simply left inaccessible to the majority of investors.

For this reason, we recommend seeking quantitative investing services that offer more accessibility. Here at RIMAR Capital, we offer comparable investing opportunities by combining powerful AI technology with the guidance of a seasoned financial advisor. Best of all, we are available to start with for as little as $1,000 on your initial investment. Contact us if you’d like to speak with one of our consultants.