Global macro funds analyze global political, economic, and other macro factors with fundamental, quantitative, technical, and other analytic tools.  They make long and short bets on a wide range of assets including equity, bonds, currencies, commodities, and derivatives.

Global macro funds often make concentrated bets and use leverage. Moreover, major geopolitical and macro events can cause violent moves and distort correlations that macro funds rely on. 

Over the last 5 years, a diversified portfolio of global macro funds had an annualized return of 8.5%, a Sharpe ratio of 1.56, and a volatility of 4.2%.  It outperformed on risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark. 

Commodity Trading Advisors (CTAs) trade derivatives of physical and financial commodities such as agriculture, energy, currency, and equity indices. Trend-following is prevalent among CTAs, although they may also use other systematic, quantitative, and fundamental strategies.

Leverage and risk are inherent in derivatives and CTAs trade on significant margins.  Therefore, risk control and stop loss are vital. Broad asset classes and trend trading enable CTAs to produce gains during broad market declines sometimes, providing diversification to a portfolio.

Over the last 5 years, a diversified portfolio of CTA funds had an annualized return of 7.9%, a Sharpe ratio of 1.41, and a volatility of 4.1%.  It outperformed on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.

Long short equity funds make bets in stocks and other equity-related securities. It profits from the price increase in long and the decline in short positions.  They use fundamental or statistical tools with flexible allocations to longs and shorts based on market conditions.

Well-managed funds avoid excessive use of derivatives and their leverage ratio – the notional value of all positions over a fund’s assets – is typically below 2. These funds are staples of alternative investment portfolios.

Over the last 5 years, a diversified portfolio of long short equity funds had an annualized return of 9.6%, a Sharpe ratio of 0.82, and a volatility of 9.3%.  It outperformed on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.

Equity market neutral is a distinct long short equity strategy that generates returns independent of overall market movements. They aim to achieve a zero beta by maintaining a balanced portfolio of longs and shorts in stocks.

Stock selections drive returns of these funds. They often deploy quantitative, fundamental, or other strategies to identify mispriced securities. These funds may also use derivatives for hedging, and leverage to amplify returns.  However, elevated leverage brings elevated risks. 

Over the last 5 years, a diversified portfolio of equity market neutral funds had an annualized return of 6.1%, a Sharpe ratio of 1.57, and a volatility of 2.6%.  It outperformed on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.

Quantitative funds utilize a wide range of quant models such as factor modeling, statistical arbitrage, trend following, and machine learning to invest. They invest in asset classes including equities, bonds, commodities, currency, and derivatives.

One main advantage of quant funds is removing emotions from the investment process. However, they rely on data analysts, programmers, IT infrastructures, and systems. Quant funds add data quality, model efficacy, and system reliability as their risk factors.  

Over the last 5 years, a diversified portfolio of quant funds had an annualized return of 11.2%, a Sharpe ratio of 1.5, and a volatility of 6.2%.  It outperformed on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.

Event-driven funds exploit mispricing which often occurs during a corporate event such as acquisitions, restructuring, regulatory actions, or earnings announcements.  They analyze the likely outcomes and bet on the difference between current and anticipated share prices.

Event driven investing requires a deep understanding of the fundamentals. However, it is worth noting that events may not occur as planned, and outcomes may differ from the anticipated.  Diversification and thorough analysis are key ingredients to success.

Over the last 5 years, a diversified portfolio of event-driven funds had an annualized return of 8.4%, a Sharpe ratio of 0.61, and a volatility of 10.4%.  It outperformed on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.

Debt funds, known as credit or fixed-income funds, invest in debt instruments. Government, corporate, and municipal bonds, asset-backed securities (ABS), collateralized loan obligations, and other securitized debt products are assets they invest with. 

Credit funds are considered less risky, even though their risks vary widely.  A leveraged distressed bond fund is highly risky, while a US treasury bills fund of no leverage is pretty safe. Credit ratings, duration, and leverage often define the risks and returns of a credit fund. 

Over the last 5 years, a diversified portfolio of debt funds had an annualized return of 4.9%, a Sharpe ratio of 0.48, and a volatility of 5.5%.  It had a low correlation with the benchmark but underperformed in absolute and risk-adjusted returns.

Distressed debt funds purchase discounted bonds, loans, and other debt instruments of entities in distress.  They use fundamental analysis to uncover mispriced securities. These funds unlock their value through restructuring, improving operations, selling assets, or liquidation.

Investing in distressed debt requires specialized expertise, risk tolerance, and patience.  A distressed situation may further deteriorate, or a new buyer may not be found.  It is essential to diversify and to be able to deal with governance and operations as necessary.

Over the last 5 years, a diversified portfolio of distressed debt funds had an annualized return of 7.9%, a Sharpe ratio of 0.77, and a volatility of 7.6%.  It outperformed on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.

Activist funds take substantial but usually minority stakes in publically listed companies they believe are undervalued.  They actively engage with other shareholders, management, and the board of directors to make changes to increase shareholder value. 

The fight for the direction and control of the companies could become heated and public, when the board, management, or other shareholders take defensive legal actions.  Activist funds may also encounter regulatory scrutiny and the risks of uncertain timelines and outcomes.

Over the last 5 years, a diversified portfolio of activist funds had an annualized return of 9.1%, a Sharpe ratio of 0.62, and a volatility of 11.7%.  It outperformed on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.

Arbitrage, in its original risk-free and market-neutral form, involves buying and selling the same security simultaneously to exploit price differences across markets or exchanges. Over time, arbitrage has evolved into strategies of buying and selling securities based on certain price relationships. These strategies are usually no longer risk-free.  Examples include:

Statistical arbitrage, known as stat arb, buys cheap and sells expensive securities based on historical price correlations.  However, such correlations could break down under market distress.  Over the last 5 years, a diversified portfolio of stat arb funds had an annualized return of 6.8%, a Sharpe ratio of 1.16, and a volatility of 4.3%.  It outperformed the S&P 500 on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.

Merger arbitrage, known as risk arb, may buy acquisition targets at discounts to the announced deal prices while short the acquirers or the broad market as a hedge. Although there is no guarantee the deals will close. Over the last 5 years, a diversified portfolio of risk arb funds had an annualized return of 6.4%, a Sharpe ratio of 0.64, and a volatility of 6.8%.  It outperformed the S&P 500 on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.

Convertible arbitrage trades on the convertibility of bonds into stocks. These funds long bonds and short stocks when they believe bonds are undervalued, or vice versa if they believe stocks are undervalued.  Convertible arbitragers incur losses when outcomes differ from their predictions. Over the last 5 years, a diversified portfolio of convertible arbitrage funds had an annualized return of 8.0%, a Sharpe ratio of 1.02, and a volatility of 5.9%.  It outperformed the S&P 500 on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.

Capital structure arbitrage, fixed income arbitrage, and volatility arbitrage are examples of many other types of arbitrage strategies.  Details differ, but these strategies all apply relative value relations to long one while short another related security. 

Arbitrage funds often use leverages and many trade securities of limited liquidity, adding additional risks. On the other hand, these funds tend to be relatively market-neutral. Unless under severe market distress, you may find funds whose returns do not correlate with others or the broader market. Carefully selected arbitrage funds could bring significant benefits of diversification to a portfolio.

Short-only funds focus exclusively on short-selling borrowed securities, expecting to buy them back at a lower price later for a profit.  Short selling performs well in bear markets but does poorly in bull markets.

Naked short selling carries unlimited risks when the security price rises instead of falls.  Also, short-only funds may use leverages and derivatives and have concentrated positions. Regulators may ban a short trade and market conditions may prevent order executions.

The most common short-only funds are short-only stock funds. However, we do not have sufficient data to report on their performance over the last 5 years.  Furthermore, the rationale of a short-only stock fund is difficult to justify when one can invest in a long-short stock fund.

Multi-strategy funds invest across different asset classes and markets using multiple investment strategies.  The risk and return profiles of these funds depend on the specific asset classes they invest in and the strategies they employ.

Over the last 5 years, a diversified portfolio of multi-strategy funds had an annualized return of 7.6%, a Sharpe ratio of 0.9, and a volatility of 6.3%.  It outperformed on a risk-adjusted basis but underperformed on absolute returns, and had a low correlation with the benchmark.