Hedge Fund Fundamentals & Strategy Types
Hedge fund interviews move fast because the job is practical: can you understand a strategy, explain how it makes money, and spot what can blow it up. This module builds a clean mental model of fund structure and the main strategy families.
Note
Module Reading: This article accompanies the Hedge Fund Fundamentals & Strategy Types module in our Hedge Fund interview prep track.
Hedge fund interviews move fast because the job is practical: can you understand a strategy, explain how it makes money, and spot what can blow it up. If you can do those three things, you are already ahead of most candidates.
In this module, you'll build a clean mental model of what hedge funds are, how they're structured, and the main strategy families (long/short equity, event-driven, macro, and quant). You'll also learn the "translation layer" interviewers care about: turning labels into drivers, risks, and real-world trade construction.
Interview Shortcut
Don't lead with buzzwords. Lead with (1) source of edge, (2) typical instruments,(3) key risk, (4) what makes it work right now. If you can do that, strategy names become almost optional.
Want to lock in the fundamentals quickly? Practice hedge fund strategy questions with instant feedback.
1) What a Hedge Fund Is (and What It Is Not)
A hedge fund is best understood as a private pooled investment vehicle with broad flexibility: it can go long and short, use leverage, and trade derivatives, often in liquid public markets. Unlike mutual funds, hedge funds are generally private and unregistered funds, and access is typically limited to sophisticated or accredited investors.
The word "hedge" is historical and sometimes misleading. Many hedge funds do hedge certain exposures (market beta, rates, FX), but the core goal is usually risk-adjusted returns, often described as alpha, or returns that are not simply explained by broad market direction.
From an interviewer's perspective, this section is about whether you understand theoperating reality: hedge funds are businesses that must (a) generate returns, (b) manage liquidity and risk daily, and (c) survive drawdowns while keeping investors, financing, and team stability intact.
Quick Interview Framing
"A hedge fund is a private investment partnership that uses a wider toolkit than traditional long-only managers. The key is not 'hedging' everything, it's targeting a repeatable edge while controlling downside and liquidity."
Which statement best explains the most fundamental operational difference between many hedge funds and traditional long-only mutual funds?
2) Structure and Ecosystem: Who Does What
Most hedge funds are run by an investment manager (the management company) that makes investment decisions, while the fund vehicle itself is often structured as a partnership-style entity. Investors contribute capital and receive fund interests; the manager earns fees and typically invests alongside clients.
Key service providers exist because hedge funds are operationally complex:
Key Service Providers
| Term | Definition | Note |
|---|---|---|
| Prime Broker | Financing, custody, clearing/settlement, and securities lending for shorting | Plus risk/margin management |
| Administrator | Independent NAV calculation, subscriptions/redemptions, investor statements | |
| Auditor | Annual audit credibility, especially important for institutional allocators | |
| Legal/Compliance | Offering docs, side letters, regulatory filings |
A common structure for global investor bases is master-feeder, where multiple feeder funds (onshore/offshore) feed into a single master trading vehicle to pool assets efficiently.
Fees and Terms: "2 and 20" Is a Shorthand, Not a Law
The classic hedge fund fee meme is "2 and 20" (2% management fee, 20% performance fee). In reality, fees vary widely and have been competitive, especially for emerging managers. Industry reporting shows emerging manager averages around 1.37% management and16.36% performance in recent years.
Most funds also include investor-protection mechanics such as:
- High-water mark – no performance fee until losses are recovered
- Lock-ups / notice periods / gates – manage liquidity pressure
- Side pockets – for illiquid/hard-to-value assets
Interview Note
Don't moralize about fees. Show you understand incentives. Performance fees can drive risk-taking, but high-water marks, risk limits, and drawdown controls shape behavior in practice.
If fee mechanics and fund terms feel fuzzy, drill them with interview-style questions until the language becomes automatic.
3) The Strategy Map: The Four Big Families
There are many sub-strategies, but most sit under four families interviewers reference constantly:
- Equity Hedge (Long/Short Equity and variants)
- Event-Driven (M&A, restructurings, special situations)
- Macro (rates, FX, commodities, equity indices; discretionary or systematic)
- Quant / Systematic (stat arb, factor, trend, volatility, multi-asset models)
A useful way to think about any hedge fund strategy is: What inefficiency is being harvested, and what risk is being warehoused? Strategy returns are rarely "free"; they are usually compensation for bearing a risk others avoid (liquidity, tail risk, leverage risk, complexity), plus skill in structuring and timing.
Strategy Cheat Sheet
| Term | Definition | Note |
|---|---|---|
| Long/Short Equity | Stock selection (alpha) + optional factor tilts | Key risks: factor crowding, short squeezes, liquidity |
| Event-Driven | Catalyst closes value gap (deal completion, restructuring) | Key risks: deal breaks, legal/regulatory shocks |
| Global Macro | Views on growth/inflation/policy in liquid markets | Key risks: regime shifts, policy surprises |
| Quant/Systematic | Model-based signals and portfolio construction | Key risks: model decay, crowded factors, tail correlation |
4) Equity Hedge: Long/Short Equity and Market Neutral
Long/short equity is the most common "entry point" strategy in interviews because it maps to stock pitching and fundamental thinking. The idea is simple: go long what you think is undervalued or improving, short what you think is overvalued or deteriorating, and manage exposure so returns come from stock selection rather than pure market direction.
Within Equity Hedge, the spectrum matters:
- Directional long/short: meaningful net exposure; you are still "taking a view" on the market.
- Market neutral: target very low net exposure (sometimes also beta-neutral), often using many positions and meaningful gross exposure.
The Exposures You Must Speak Fluently
Interviewers often pressure-test whether you can translate a portfolio into exposures quickly:
Gross Exposure = (|Longs| + |Shorts|) / NAVTotal 'risk on' – how much position exposure relative to capital
Net Exposure = (Longs − Shorts) / NAVDirectional exposure – positive means net long, negative means net short
Why it matters: two funds can both be "long/short equity" but behave totally differently in a selloff depending on net, gross, factor tilts, and liquidity.
Important Nuance
A "low net" portfolio can still be risky if gross is high and positions are crowded, because correlations can spike and liquidity can vanish when everyone exits together.
A hedge fund has NAV of $100m. It is long $140m of equities and short $90m of equities. What are gross and net exposures?
5) Event-Driven: Merger Arb, Distressed, and Special Situations
Event-driven strategies monetize situations where a specific corporate catalyst should close a pricing gap. The key difference versus long/short equity is that the thesis is not "this company is great," it's "this event will resolve, and the security will reprice accordingly."
Merger Arbitrage (M&A Arb)
Classic setup: target trades below the announced deal price due to uncertainty (timing, financing, antitrust). The "spread" is your potential return, but you are short a form of tail risk: if the deal breaks, the target can gap down hard.
Distressed and Restructuring
Distressed investing focuses on securities of firms in or near bankruptcy and often requires understanding the capital structure, legal process, and recovery values. Returns can be attractive but can also be illiquid and cyclical.
Interview Tell
If you can explain why the spread exists (regulatory probability, financing, timing, litigation, shareholder vote) and how you size it, you sound like a practitioner, not a student.
A company announces it will acquire TargetCo for $50 cash. TargetCo trades at $48. If the deal breaks, you estimate TargetCo falls to $40. If you believe there is an 80% chance of closing, what is the expected value of buying TargetCo at $48 (ignoring time value)?
Event-driven interviews are about payoff diagrams and deal-break risk. Practice until you can explain spreads, catalysts, and downside cleanly.
6) Macro and Quant: Discretionary Views vs Systematic Edges
Global macro trades the world through liquid instruments. The "raw material" is macro variables: growth, inflation, monetary and fiscal policy, geopolitics, and market positioning. Strategies can be discretionary (PM judgment) or systematic (rules/models).
A strong macro interview answer includes:
- The macro regime you think we're in (and what would change it)
- The transmission mechanism (how inflation prints change rates, rates change FX, FX changes equities)
- The instrument choice (futures, options, swaps) and why (liquidity, convexity, carry)
- The risk (policy surprise, regime shift, correlation flip)
Quant / systematic is not one strategy, it's a way of building strategies: signals, portfolio construction, and execution rules. That can include:
- Stat arb / equity market neutral (mean reversion, relative mispricings)
- Trend / CTA (time-series momentum across futures)
- Factor portfolios (value, quality, momentum, low risk)
- Volatility strategies (carry, term structure, dispersion)
Reality Check
Don't oversell "AI" in interviews. Treat it as a tool. What matters is whether you understand (1) signal decay, (2) crowding, (3) execution costs, and (4) tail correlation when models break.
Key Takeaways
What You Should Remember
- A hedge fund is a private pooled vehicle with broad flexibility (shorting, leverage, derivatives) and typically limited investor access.
- The ecosystem matters: prime broker, admin, audit, and legal are not "back office," they shape what trades are feasible.
- Strategy labels are less important than: edge, instruments, holding period, and failure mode.
- Long/short equity interviews revolve around exposures (gross/net), factor risk, and short-specific risks.
- Event-driven is "catalyst investing," and merger arb is defined by asymmetry and deal-break tail risk.
- Macro is about regimes and transmission mechanisms; quant is about signal quality, portfolio construction, and costs.
- "2 and 20" is a shorthand; real-world fees vary and have been competitive, especially for emerging managers.
Continue Your Hedge Fund Interview Prep
Master these related topics to complete your hedge fund interview preparation:
- Hedge Fund Market Analysis & Investment Ideas — How to generate and defend trade ideas in interviews
- Hedge Fund Valuation & Price Targets — Turn analysis into tradable price targets
- Hedge Fund Trading & Execution — Order types, benchmarks, and short mechanics
- Hedge Fund Portfolio Construction — Gross/net exposure, position sizing, and risk management
- Hedge Fund Stock Pitch Mini Cases — Practice long and short pitch frameworks
- Hedge Fund Macro Scenarios & Market Judgment — Economic scenarios and articulating conviction
Foundational Topics
- Enterprise Value vs Equity Value — Essential valuation concept
- Walk Me Through a DCF — Core valuation methodology
- How the 3 Financial Statements Link — Accounting fundamentals