A large component of portfolio managers’ responsibilities will be risk management; managing risk well turns volatility into opportunities.  The defining characteristics that differentiate hedge funds from traditional long-only mutual funds are the use of leverage.

Hedge fund strategies incorporate the use of short selling and derivates to minimize overall market risk exposure.  In bull markets hedge funds may have net long exposure, meaning the securities held in their portfolio are positioned more long than short.  Running a net long exposure, the fund’s objectives are for the long positions to outperform the market while their short positions underperform.

In a bear market, hedge funds may chose to run a net short exposure, meaning the securities held in their portfolio are positioned more short than long.  Running a net short exposure, the fund is anticipating its short sale of equities to underperform the overall market.

Mutual funds strategies will take into account stock picking techniques that will outperform the overall market.

Hedge funds will also use derivatives to hedge out market risk. Put options can be purchased for individual stocks, allowing the fund to sell the underlying securities at a predetermined price (i.e. strike price).