Hedge Funds: Definitive Strategies and Techniques
Kenneth S. Phillips and Ronald J. Surz (editors) · 2003 · 226 pages
Ten industry practitioners explain how the major hedge fund strategies actually work, with real trade math for convertible and merger arbitrage. It is written for the institutional allocator deciding where to place money, not for someone hoping to run these strategies themselves.
The one idea
This is not a trading system book. It is a reference assembled by the Investment Management Consultants Association: ten separate chapters, each written by a different specialist, walking through how a category of hedge fund strategy generates return, how institutional investors measure and compare managers, and how risk gets managed once capital is committed. The chapters on alpha determination, arbitrage, global macro, managed futures, manager searches, and risk management each stand alone and can be read independently.
The thread connecting them is a single argument: traditional stock and bond benchmarks (Sharpe ratio, CAPM beta) badly understate or overstate what a given hedge fund strategy is actually doing, so an allocator needs strategy-specific tools to tell skill from market exposure, and strategy-specific due diligence to tell a durable edge from a crowded trade about to break.
The strongest material is the arbitrage chapter, which walks through actual position construction: how a convertible bond arbitrage trade is set up, what happens to the P&L when the stock moves 25% either way, and how merger arbitrage spreads compress as a deal closes. The weakest is the risk management chapter, which leans heavily on proprietary CMRA figures and diagrams that do not survive text extraction and reads more like a consulting slide deck than a chapter.
What it actually teaches
The book does not build toward one sequential method; it delivers four distinct bodies of practical material an allocator needs, in this order of usefulness.
ALPHA DETERMINATION
Chapter 2 walks through why the same hedge fund strategy shows wildly different 'alpha' depending on the benchmark used. Using 1990-2000 data, the HFRI Equity Hedge Index shows 15.9% excess return over the risk-free rate but only 9.4% once measured against a multifactor model; the HFRI Fixed Income Arbitrage Index actually shows negative alpha (-0.2%) once volume-adjusted. The lesson: never trust a manager's stated alpha without knowing which benchmark produced it.
ARBITRAGE STRATEGY MECHANICS
Chapter 5 gives worked numbers. A convertible bond arbitrage position (long a $1,000 convertible paying 5%, short 50 shares of the underlying at $10) nets a 6.125% annual return if the stock does not move, 18.625% if it rises 25%, and 8.625% if it falls 25%, because the short leg profits enough to offset the bond's loss. The book pegs unleveraged convertible arbitrage's realistic return, as of 2003, at 'slightly below 10%,' down from roughly 20% a decade earlier, because of falling rates, rising equity volatility, wider credit spreads, and new competition.
MANAGER DUE DILIGENCE
Chapter 8 compares the three leading hedge fund databases of the time (HedgeFund.net, HFR, Tass) on coverage and reporting lag: roughly 82-85% of listed funds had reported performance 30 days after month end, rising to 90-93% after 60 days. It flags that free databases skew toward smaller managers (HedgeFund.net's median fund runs well under $25 million AUM) while paid databases like HFR and Tass carry more funds above $500 million, so a single-database search misses whole segments of the manager universe.
RISK MANAGEMENT FRAMEWORK
Chapter 9 argues Value at Risk (VaR) is only one tool and cannot be the whole risk process, citing a claim of at least one 10-standard-deviation market event every year for the prior decade. Its practical rule: only about a third of a sound risk management program is quantitative; the rest is qualitative judgment, stress testing (what happens if all correlations go to 1, or the prime broker widens repo haircuts), and risk transparency negotiated directly with the manager.
What it looks like Monday morning
An allocator or consultant walks away with a concrete checklist: ask any hedge fund manager which benchmark they used to compute their stated alpha, cross-reference at least two manager databases rather than one (their fund coverage barely overlaps), and ask specifically for stress test results and VaR methodology rather than accepting a single risk number at face value.
A retail reader looking for something to trade personally gets almost nothing usable. The convertible and merger arbitrage math is illustrative, not a system: it requires the ability to short stock, borrow shares, access repo financing, and price embedded options, none of which the book teaches you to do.
| Scenario | Net cash flow | Annual return |
|---|---|---|
| Stock price unchanged | $61.25 | 6.125% |
| Stock rises 25% | $186.25 | 18.625% |
| Stock falls 25% | $86.25 | 8.625% |
The short stock leg is sized to profit whether the stock rises or falls, so the position earns a positive return in all three scenarios; the book uses this to show why the hedge, not just the bond's yield, is the source of return.
Risk management is not about eliminating risk. It is about making sure one understands the risks one takes.Leslie Rahl, Hedge Funds: Definitive Strategies and Techniques
Where it fails
- The convertible arbitrage numbers did not survive 2008. The book calls unleveraged convertible arbitrage, at roughly 10% return with 3.9% annual standard deviation over 1993-2002, 'one of the best hedge fund strategies,' while already warning of 'overcrowding issues.' That overcrowding, combined with the leverage the book says managers were adding to compensate for falling returns, is exactly what caused convertible arbitrage funds to suffer some of the worst losses of any hedge fund strategy in the 2008 crisis. The book was written five years before its own warning played out.
- Every hard number in the book stops in 2002. Table 5.1's arbitrage return comparison runs through July 2002. Tables 2.3 and 2.4's alpha determination data covers 1990-2000. None of this reflects the 2007 quant crash that hit statistical arbitrage and market-neutral equity funds simultaneously, the 2008 financial crisis, the post-2008 near-zero rate era that gutted fixed income arbitrage carry, or the Dodd-Frank-era transparency and leverage rules that changed prime brokerage terms industry-wide.
- Chapter 8's database landscape is now a museum piece. HedgeFund.net, MARHedge, and Altvest, all treated in Chapter 8 as the practical starting points for a manager search, have since been acquired, merged, or shut down. A reader trying to use this chapter as an actual resource guide today would find most of the named vendors no longer exist in that form.
- It assumes an allocator's infrastructure, not a trader's. The book is written for someone who can negotiate position-level transparency with a hedge fund manager, subscribe to commercial databases, and run internal risk systems against a manager's reported VaR. A solo trader or small investor has none of that access and cannot act on most of the book's advice.
- Chapter 9 leans on figures that do not survive outside the printed page. Roughly half of the risk management chapter is captioned proprietary CMRA diagrams (the 'Galaxy of Risks,' 'Transparency Tug-of-War,' stress testing approach charts) with almost no accompanying explanatory text. Read as prose, the chapter is thinner than its page count suggests.
- Every chapter shows its own strategy's winners, not its casualties. The merger arbitrage section notes only about 3% of announced friendly deals break, and frames this as evidence the strategy is safe; it does not walk through what a concentrated position in a broken deal actually costs a fund, beyond the single hypothetical example given.
Who it is for
Buy it if
You are an institutional allocator, consultant, or advisor who needs a plain-English map of how the main hedge fund strategy categories generate return, and you want real worked examples of arbitrage trade construction rather than marketing language. The convertible and merger arbitrage chapters are worth the price alone for that purpose.
Skip it if
You are looking for a system you can trade yourself, you need current data (everything here predates 2008 and the post-crisis regulatory regime), or you want one coherent authorial voice rather than ten practitioners writing ten separate chapters of uneven depth.
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