Long-short funds: The strategy your portfolio needs

Introduction

Long-short funds, also known as market-neutral funds, are an important element of any portfolio. This investment strategy involves taking long positions in stocks that are expected to gain value and short positions in stocks you think will decrease in value. This strategy can help you protect your portfolio from volatile markets, and it can be used to generate returns regardless of which way the market goes.

Unlike the traditional buy-and-hold approach, long-short funds seek to create returns through stock picking and stock hedging, which means investing in stocks that you think will outperform the market, and shorting stocks you believe will underperform. Let’s dive deep into long-short funds.

What Are Long-Short Funds?

Long-short funds begin by taking a long position in stocks expected to rise in value and a short position in stocks that are expected to decline. This strategy risks losing money on the long positions if stock prices fall, but profits on the shorts should offset any losses.

Long-short funds are considered to be more efficient than traditional equity investing because they minimize the risk by allowing investors to buy and sell stocks in a balanced manner. As there is no single, or large bet on a stock’s performance, investors can expect returns up to 3 to 5 percent higher than their traditional equity counterparts.

Long-short funds are a great way to diversify a portfolio and are quite a popular choice among experienced investors looking for more risk management. While they may not reduce the overall risk associated with stock investments, they can provide investors with a way to diversify their holdings and maximize their potential returns.

What Is Unique About Them?

Unlike other traditional funds that purchase stocks or bonds, long-short funds allow a greater opportunity for returns by investing in both long and short positions. This means that when market prices move in one direction, the fund manager can take advantage of this trend and take a long position, while in the other direction, he can take a short position to profit from decreases in the market.

Another advantage of long-short funds, when compared to traditional funds, is that it allows for more control over investment risk. Balancing the portfolio with both long and short positions minimizes the risk of any single move impacting the entire portfolio, making it more resilient to volatile market conditions.

Overall, long-short funds provide investors with a unique opportunity to take advantage of both long and short-market trends with the huge potential to gain greater returns than traditional investments. It also offers investors the added benefit of more control.

How Does Long-Short Funds Add Value To Your Portfolio?

Long-short funds often take large positions in stocks while short posts are meant to hedge the long-term and reduce the risk of large losses. This strategy can be beneficial when the market is volatile and allows the investor to benefit from both, rising and falling prices. By positioning themselves as both, a buyer and a stock seller, long-short funds balance out the risk of holding an individual supply for a long time.

An additional advantage of long-short funds is that they can be used as leverage. This means, the funds can borrow from banks or other lenders to increase their return on investment. By utilizing this option, investors can make much larger bets than would be possible with just their own money. This also allows these funds to take larger risks which could result in higher returns and greater losses if the market turns against them.

Long-Short Equity vs. Equity Market Neutral

A long-short equity fund differs from an equity market neutral (EMN) fund in that the latter attempts to exploit differences in stock prices by being long and short in closely related stocks that have similar characteristics.

An EMN strategy attempts to keep the total value of their long and short holdings roughly equal, as this helps to lower the overall risk. To maintain this equivalency between long and short, equity market neutral funds must rebalance as market trends establish and strengthen.

So as other long-short hedge funds let profits run on market trends and even leverage up to amplify them, equity market neutral funds are actively staunching returns and increasing the size of the opposite position. When the market inevitably turns again, equity market neutral funds again whittle down the position that should profit to move more into the portfolio that is suffering.

A hedge fund with an equity market neutral strategy is generally aiming itself at institutional investors who are shopping for a hedge fund that can outperform bonds without carrying the high risk and high reward profile of more aggressive funds.

Why Should One Invest In Long-Short Funds?

Long-short funds also provide a means to hedge against market volatility, as this fund allows investors to invest in both stocks and bonds simultaneously. This hedge is beneficial because it will enable investors to take advantage of stock gains while avoiding possible losses caused by sharp market movements. Furthermore, long-short funds allow investors to quickly realize returns if markets suddenly move in the opposite direction.

The Bottom Line

Overall, long-short funds are a great option for investors who want to be able to take advantage of potential market trends while managing the risk associated with investing in individual stocks or assets. By allowing hedging against market movements, long-short funds provide a valuable tool for investors who wish to build a diverse portfolio with the potential to provide consistent returns over the long term.