Alternative Strategy Funds: Exploring Flexibility and Strategy Groups

20.3 Alternative Strategy Funds

Alternative strategy funds represent a dynamic and flexible approach to investing, diverging from the traditional paths of conventional mutual funds. These funds employ a variety of sophisticated strategies to achieve their investment objectives, often seeking to capitalize on market inefficiencies, hedge against risks, or enhance returns through innovative techniques. In this section, we will delve into the intricacies of alternative strategy funds, explore the three main strategy groups, and discuss how these strategies can lead to distinct risk and return profiles compared to traditional investments.

Understanding Alternative Strategy Funds

Alternative strategy funds are investment vehicles that utilize non-traditional strategies to achieve their goals. Unlike conventional mutual funds, which typically invest in stocks, bonds, or a combination of both, alternative strategy funds may engage in a wide range of investment activities, including short selling, leverage, derivatives, and arbitrage. This flexibility allows them to pursue absolute returns, meaning they aim to generate positive returns regardless of market conditions.

Key Characteristics of Alternative Strategy Funds

1. Flexibility: These funds can adapt to changing market conditions by employing various strategies, including hedging and leveraging, to optimize returns.
2. Diverse Strategies: They encompass a broad spectrum of investment strategies, each with unique risk and return characteristics.
3. Risk Management: Alternative strategy funds often focus on risk-adjusted returns, using techniques like hedging to mitigate potential losses.

Strategy Groups within Alternative Strategy Funds

Alternative strategy funds can be broadly categorized into three main strategy groups: Relative Value, Event-Driven, and Directional. Each group employs distinct approaches to achieve its investment objectives.

1. Relative Value Strategies

Relative value strategies aim to exploit pricing inefficiencies between related financial instruments. These strategies often involve arbitrage, where investors simultaneously buy and sell similar securities to profit from price discrepancies.

• Example: A Canadian hedge fund might engage in convertible bond arbitrage, purchasing convertible bonds and shorting the underlying stock to profit from pricing inefficiencies.

• Risk and Return Profile: Relative value strategies typically offer moderate returns with lower volatility, as they focus on market-neutral positions that are less affected by broad market movements.

2. Event-Driven Strategies

Event-driven strategies seek to capitalize on specific corporate events, such as mergers, acquisitions, restructurings, or bankruptcies. These strategies rely on the anticipation of how such events will impact the value of a company’s securities.

• Example: An event-driven fund in Canada might invest in a company undergoing a merger, betting that the merger will increase the stock’s value.

• Risk and Return Profile: These strategies can offer substantial returns, but they also carry higher risks due to the uncertainty surrounding corporate events.

3. Directional Strategies

Directional strategies take positions based on the anticipated direction of market movements. These strategies may involve long or short positions in various asset classes, including equities, commodities, or currencies.

• Example: A Canadian alternative strategy fund might take a long position in energy stocks, anticipating a rise in oil prices.

• Risk and Return Profile: Directional strategies can lead to significant gains or losses, as they are highly dependent on market trends and movements.

Risk and Return Profiles

The risk and return profiles of alternative strategy funds differ significantly from traditional investments. While traditional mutual funds often aim to match or exceed market benchmarks, alternative strategy funds focus on absolute returns, seeking to generate positive returns regardless of market conditions. This approach can lead to:

• Higher Potential Returns: By employing leverage and sophisticated strategies, alternative funds can achieve higher returns than traditional funds.
• Increased Risk: The use of leverage and complex strategies can also amplify losses, making risk management crucial.
• Diversification Benefits: These funds can provide diversification benefits to a portfolio, as their returns are often uncorrelated with traditional asset classes.

Glossary

• Arbitrage: The simultaneous purchase and sale of an asset to profit from an imbalance in the price.
• Leverage: The use of borrowed capital to increase the potential return of an investment.

Canadian Regulatory Framework

In Canada, alternative strategy funds are subject to specific regulations to ensure investor protection and market integrity. One key regulation is National Instrument 81-102, which governs mutual funds and provides guidelines for alternative funds, including leverage limits and disclosure requirements.

Additional Resources for Further Exploration

For those interested in deepening their understanding of alternative strategy funds, consider exploring the following resources:

• Books:
  • “Hedge Fund Strategies: An Inside Look at the Investment Strategies of Hedge Funds and Private Equity” by Filippo Stefanini.

These resources provide valuable insights into the strategies and operations of alternative funds, offering a comprehensive view of their role in modern investment portfolios.

Conclusion

Alternative strategy funds offer a compelling investment option for those seeking to diversify their portfolios and pursue absolute returns. By understanding the various strategies employed by these funds and their associated risks and returns, investors can make informed decisions that align with their financial goals. As the Canadian financial landscape continues to evolve, alternative strategy funds will remain a vital component of sophisticated investment strategies.

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