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The Little Book of Alternative Investments: Reaping Rewards by Daring to be Different by Phil DeMuth, Ben Stein

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Chapter Nine

A Field Guide to Hedge Funds, Part One

The Long and the Short of It

We once met a prosperous hedge fund manager and asked him the secret of his success. He told us that his method is to comb through the newspapers every day, and whenever he reads about a graduate of USC business school being promoted to CEO of a company, he shorts their stock. While this particular strategy is not widespread as far as we can determine, one of the key features that distinguish hedge funds from conventional investments is short selling. Most mutual funds constrain managers to buy only the stocks they think will go up. Then, under the Taxpayer Relief Act of 1997, the last restriction on short selling in mutual funds was removed, and the result was a spate of new investment products that let investors swing both ways.

This chapter is going to be about those hedge funds whose short selling is central to their strategy. As you have gathered by now, there is not just one type of hedge fund. In fact, there are 10 basic hedge fund types as handed down on the tablets from Dow Jones Credit Suisse. If you want to use somebody else’s classification scheme, be our guest. Our plan is to give you a primer on them here and then focus later on some specific mutual funds who run these strategies.

#1. Long/Short Equity

Long/short equity hedge fund strategies purchase securities that the managers believe will rise (the “long” part) in value while simultaneously shorting others that they believe will fall ...

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