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- Allocation refers to the placement of hedge fund financial resources into a particular investment opportunity. A hedge fund is typically managed by one or more hedge fund managers who make the allocation decisions on behalf of their investors. There are a variety of different strategies employed by hedge fund managers; however, the basic process of trade allocation is fairly consistent on a broad level.
- An important initial distinction should be made between asset allocation done bottom-up versus top-down. Bottom-up asset allocation focuses on looking at specific securities or individual investment opportunities, while top-down instead looks initially at which markets appear attractive and then looks for securities or investments within those markets. While the bottom-up approach is more traditional, the top-down approach is becoming increasingly more common.
- The fist stage in the hedge fund trade allocation process is known as strategic allocation. During this stage, hedge fund managers look at the goals of the investors in their funds as well as the constraints facing the investors. Essentially, the fund manager seeks to create a strategy that reaches or exceeds the fund members' desired return while staying at or below their acceptable level of risk. The fund manager will create a portfolio that, in the long term, should meet both these goals.
- Tactical allocation refers to shorter-term trade decisions that seek to take advantage of shifting risk-return dynamics within the strategic portfolio. For example, stock in ABC Corporation might be within the broader strategic allocation plan of a hedge fund; however, changes in the outlook for the performance of that stock might cause a hedge fund manager to buy or sell larger amounts of the security in the short term.
Allocation
Bottom-Up Versus Top-Down
Strategic Allocation
Tactical Allocation
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