But to answer your question, a market neutral hedge fund might buy one stock while simultaneously short selling another stock. The position is "neutral" because if the stock market as a whole moves up or down, one position makes money while the other loses money and they cancel eachother out. However over the longer term, the fund manager is betting that the long position (the one the manager bought) will go up in value while the short position (the one that was short sold) will decline in value. This would result in the fund making a profit without being exposed to a large price change in the stock market as a whole.
So the theory is that risk can be reduced by investing in negatively correlated positions, but hopefully over time each position generates a positive return.
The world is full of investments that aren't stocks. At hedge funds I have worked at or owned we have owned a satellite, bankruptcy claims in Venezuela, leases from bankrupt companies like K-Mart, bonding facilities, basket correlation swaps, electricity price guarantees, coal forward contracts, mountains of grain, Italian savings bonds, credit default obligations based on airplane leases, etc, etc....
Hedge funds are a broad term, it does not mean they hedge all investments. Mostly they are bully, activist shareholders who force company Boards into short term decisions to maximize immediate shareholder value instead of long term decisions that would be better for the company and the economy.
I understand that hedge funds use stocks that are negatively correlated to reduce risk. My question is how can there be any return at all if you are investing in stocks that are negatively correlated?
