ZK Series: What is a Hedge Fund?
- What is a hedge fund?
- How does a hedge fund work in practice?
- Common hedge fund strategies
- Pros and cons
- How the ZK Fund fits into this framework
- Conclusion
Key takeaways
- A hedge fund is a flexible fund structure. It can use a broad toolkit of strategies and instruments to generate returns, even when markets fall.
- Returns often come from inefficiencies, not just price appreciation. Hedge funds may use long and short positioning, derivatives, and relative value strategies.
- Flexibility requires strong risk management. The opportunity set is wider, but success depends on disciplined execution and robust controls.
What is a hedge fund?
A hedge fund is an investment fund with one defining feature: flexibility. Unlike many traditional funds, which are often mostly long-only, hedge funds can typically deploy a broader range of strategies. This may include combining long and short positions, using derivatives such as futures and options, and exploiting price differences across markets.
The word “hedge” literally means to offset or protect. Hedge funds originally emerged with the idea that you can reduce risk by hedging exposures. Today, the term largely reflects something broader: a fund that has more tools to manage risk and generate returns, especially when markets do not move in a straight line.
How does a hedge fund work?
The core idea is that a hedge fund does not want to rely on a single scenario, such as “the market goes up.” Instead, it aims to generate returns through multiple sources, for example:
- Returns from price appreciation (long)
- Returns from price declines (short)
- Returns from price differences across instruments (arbitrage or basis trades)
- Returns from premium capture or protection through options
- Returns from relative value relationships (pairs trading or spreads)
Because hedge funds can position both with and against markets, they often focus on risk-adjusted performance. Not only how much they earn, but how consistently they earn it.
Common hedge fund strategies
Hedge funds can look very different from one another, but several strategy types are common:
Long and short strategies
A fund goes long assets it finds attractive and shorts assets it finds less attractive. The goal is to profit from relative performance while reducing exposure to broad market moves.
Market-neutral strategies
These strategies aim to neutralize market beta by balancing long and short exposures. Returns are driven by inefficiencies, spreads, or funding rates, not by market direction.
Arbitrage and relative value
This includes price differences between spot and futures (cash and carry), across exchanges, or between closely related assets. The thesis is that mispricings tend to converge over time.
Event-driven or tactical positioning
Some hedge funds trade around specific catalysts, such as listings, upgrades, or regulatory developments, or take tactical exposure when the risk and reward is strongly asymmetric.
A key point is that hedge funds are rarely built around a single tactic. The strength often lies in combining strategies that perform differently across market conditions.
Pros of hedge funds
Below are the most well-known benefits that a hedge fund offers investors.
- More ways to generate returns
With a broader mandate, hedge funds can access opportunities that long-only funds typically cannot.
- Less dependence on market direction
Many hedge fund approaches are designed to perform in sideways or declining markets as well.
- Focus on risk management and stability
Well-managed hedge funds often prioritize drawdown control, lower volatility, and higher Sharpe ratios.
- Portfolio diversification
Because return drivers can differ from traditional long-only exposures, hedge funds may improve overall portfolio balance.
Cons and considerations
As with any other subject, there are also cons. Below are the most known drawbacks of hedge funds.
- Complexity
Hedge fund strategies can be technical and harder to understand than simple buy-and-hold investing. Clear communication and strong governance matter.
- Risk still exists
Hedging does not eliminate risk. Market stress, liquidity constraints, model risk, counterparty risk, and operational risk can all play a role. These risks must be mitigated properly.
- Fee structures
Hedge funds are often more expensive than passive products due to active management, research, and infrastructure. The exact structure differs per fund.
- Execution matters
A broad toolkit is only valuable if it is used with discipline. Results depend heavily on risk controls, systems, and experience.
The Hodl ZK Fund as a hedge fund
The Hodl ZK Fund functions as a hedge fund in the sense that it can deploy a broad set of tools and strategies to pursue attractive, controlled returns. The fund combines:
- Market-neutral strategies designed to reduce dependence on market direction
- High-Sharpe strategies focused on efficient use of risk
- An infrastructure built for continuous monitoring and execution in a 24/7 market
The objective is not simply to participate when crypto rallies, but to deliver stable, risk-adjusted returns across different market regimes.
Conclusion
A hedge fund is not a standard investment fund. It is a flexible structure that can use multiple strategies and instruments to pursue returns, hedge exposures, and reduce reliance on market direction. That flexibility can be powerful, but it also requires strong risk management, technology, and experience.
The Hodl ZK Fund fits within this framework. It applies hedge fund principles with a focus on market-neutral and high-Sharpe strategies, aimed at stability and risk-adjusted growth in crypto.
Want to learn more about the inner workings of the ZK Fund? We are hosting several ZK Knowledge Sessions in our office in Rotterdam. You can sign up via the button below. Not able to make it to our office? Then our specialists are ready for you in a personal online meeting.
