Hedge Funds operational strategies: evaluating the exposure of market risk factors on fund returns

Hedge funds have been the subject of both fascination and mystery due to their exclusive and secretive nature. Unlike other types of investment vehicles, hedge funds are typically only available to qualified or accredited investors and this has led to a perception that hedge funds operate in a world of secrecy and exclusivity, making them mysterious and alluring to many people. The hedge fund industry has experienced significant growth in recent decades and the hedge funds investment strategies have become increasingly important to understand. The global financial crisis has demonstrated that even financial experts are unable to predict all aspects of the future. The crisis, which began in the United States, quickly spread globally, resulting in consecutive drops in stock market indices. This underscores the interconnectedness of financial markets. Investing in these markets entails exposure to both regional and global risk factors, which can be challenging to anticipate. Hedge funds typically use a range of sophisticated investment strategies to generate high returns; however, it involves taking on greater exposure to market risks than traditional funds. Market risk refers to the potential financial loss resulting from changes in market prices, such as interest rates, foreign exchange rates, commodity prices, or equity prices. The purpose of this thesis is to provide a comprehensive overview of hedge funds structures highlighting the main features of this investment vehicle while providing a statistical analysis to evaluate the exposure of the market risk variables on the returns of the different strategies employed by the funds. The first chapter discuss the hedge fund’s structure and their various characteristics, including their historical evolution, types, typologies of investor, fee’s structure, leverage adoption, costs, regulatory and fiscal framework highlighting the main difference across the globe. The second chapter will focus on describing the different hedge fund strategies subdivided into three main categories starting from the less risky and less profitable to the high risky and high profitable: respectively, market neutral, event driven and directional strategies. This chapter will provide a comprehensive overview of the functioning and the main features of each specific strategy and serve as a base for the analysis conducted in the next chapter. The third chapter will evaluate through a statistical analysis the exposure to market risk factors of hedge fund strategies to understand the magnitude and the direction of the relationship between these variables highlighting what factors impact the strategies the most. This research is based on previous works where the authors investigated the impact of market risk factors on the returns of hedge funds, as well as how the effects of these risk factors may differ across various hedge fund strategies. Keeping in mind these premises we will try to answer the following questions: How do market risk factors affect the return of hedge funds? How may the effects of these risk factors vary across different hedge fund strategies? This work has been accomplished using regression analysis and other statistic techniques to provide valuable insights into the magnitude and the direction of the exposure to the risks on the different hedge fund strategies, in particular we employed R-Studio to perform this analysis highlighting the main features of the multiple linear regression for each investment strategy. This work may serve as a base for further analysis, helping investors to make more informed decisions. Incorporating this information into risk models can help investors build more accurate models and make more informed investment decisions. However, since the Multiple Linear Regression model suffers from several limitations, we suggest further analysis to better understand the risk exposure of the different strategies.