The Long and the Short of it

Long/Short funds are basically hedge funds where the fund managers look for ways of beating the normal equity markets over a certain period of time.
The basics are surprisingly easy. Good analysis and research should unveil potential situations where there are winners and losers. Where the fund tries to make money is by investing in both. This is one of the big factors of a Long/Short fund as it allows managers to go both sides of the track.
What happens is that the Long/Short fund manager will buy ‘long’ positions in stocks and shares which he/she reckon will go up in value but also ‘shorts’ positions where it is believed the purchase will go down in price. Alternatively, they can offer a ‘hedge’ against a particular market or sector risk. This is called the ‘Short book’.
This specific combination of ‘Long’ and ‘Short’ increases the possibility of making more profit whilst reducing the risk factor. The theory is that Long/Short equity funds aim for good margins without the volatility. They are also able, via the “short book” they have, to show a negative view on something or to hedge risk when things do get more volatile. This allows the fund to miss out on the downside and take advantage of the upside.
Does this always work, absolutely not - just look at the likes of Long-term Capital Management which, after a great start in the first three years (it grew by over 300% after all charges in four years), managed to lose over USD4.6 billion in four months due to the Asian and Russian Financial Crises at the end of the 1990’s. However, there are excellent funds that do know what they are doing. They will use a fundamental ideology or quantitative analysis to help with investment choices.
The former can come in the shape of an individual who is responsible for almost everything or a multi-manager, multi-strategy portfolio which will be more diversified.
The latter will seek returns over all geo-political and sectoral areas and study both the fundamentals and technicals before coming to a decision. In fact some will only allow computers to analyse what is going on and so leave the human element out of it all together. However, the normality of it is that Long/Short fund managers are no different to others in that they do nothing more than use their own experience, skill and hedging knowledge to try to get the optimal growth possible. A good one though will be able to reduce market exposure before any corrections thereby protecting capital and producing growth over the long term.
Many indices have done well over the last decade or so, even accounting for a couple of horrible years. However, many Long/Short strategy hedge funds have even outperformed the indices and they have done this with less volatility.
One more thing that makes Long/Short equity funds of interest to many people is that they are usually very liquid thus allowing the manager to adapt his portfolio quickly and, efficiently which will enable the fund to take advantage of the upside and avoid the downside.
As stated above, the results of a Long/Short equity fund is down to the management performance of the fund. The long and the short of it is that everyone should have some exposure to these type of investment products in their portfolio.

 

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