The document provides information on long/short equity hedge funds:
- Long/short equity funds buy stocks they believe will increase in value and short stocks they believe will decrease, aiming to outperform markets while reducing risk.
- They have flexibility to take long or short positions and can generate returns in both rising and falling markets.
- Studies show long/short equity funds have outperformed the S&P 500 with lower volatility, providing better risk-adjusted returns over the past 10 years.
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Long/Short Equity Fund Advantages
1. Hedge Fund Portfolio Soutions for Advisors
H E D G E F U N D S T R AT E G I E S
Long/Short Equity
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2. Hedge Fund Portfolio Soutions for Advisors
Introduction
Long/Short Equity
Hedge Fund Strategy
The long/short equity strategy is one of the more nimble hedge
The long/short equity fund manager buys long positions in stocks
fund strategies whereby managers seek opportunities across
they believe will increase in value (“the long book”) and shorts
global equity markets with the objective of outperforming tradi-
positions which they feel will decrease or offer a suitable hedge
tional markets over a given cycle.
against certain market or sector risk (“the short book”).
The concept behind the long/short equity strategy is simple:
The combined portfolio creates enhanced opportunities for idio-
investment research uncovers expected winners and losers
syncratic (i.e. stock-specific) gains and reduces market risk as
and the hedge fund enhances its potential return capabilities by
the short holdings offset the long market exposure.
taking a position in both.
In all, long/short equity managers largely target equity-like re-
Accordingly, one of the major advantages of the long/short eq-
turns without the high volatility typically associated with long-only
uity strategy is that the managers have the flexibility to express
strategies in order to provide a higher compounded rate of return
their views in opposite directions.
over time.
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3. Hedge Fund Portfolio Soutions for Advisors
What are
Long/Short
Equity Funds?
Long/short equity managers are active in equity and equity
Nonetheless, the objective of the fundamental long/short
derivative securities in which they maintain both long and short
manager is to uncover opportunities through deep bottoms-
positions in order to generate returns. The managers aim to de-
up analysis where they aim to identify the intrinsic value of a
liver returns in excess of the broad equity markets while seeking
company.
to assume less risk in the process.
The fundamental investment approach to long/short equity can
Unlike traditional long-only equity managers, those that pursue
also be exercised through a single portfolio manager approach
the long/short equity strategy have the ability to use their “short
where there is a sole risk-taker responsible for initiating and siz-
book” to express a negative view on a stock or as a means to
ing positions or within the context of a multi-manager, multi-strat-
hedge market risk in periods of heightened volatility.
egy structure, which has the potential to offer a more diversified
As a result, long/short equity funds are generally able to sidestep
return stream.
large drawdowns and compound returns in a more attractive
Alternatively, managers who utilize a quantitative approach to
fashion than what is available in the long-only equity world.
uncovering value in the long/short equity space tend to be broad-
The universe of long/short equity hedge funds is quite broad
with managers in the space implementing the strategy through
er in nature and seek opportunities across all and any sector
through the use of both fundamental and technical factors.
a fundamental investment approach or by utilizing quantitative
Finally, managers within the long/short equity strategy can fur-
methods to arrive at investment decisions.
ther distinguish themselves through the levels of gross and net
In general, managers who employ a fundamental research approach can be specialists in certain sectors (e.g., technology,
healthcare, financials, etc.) or sector agnostic and pursue a
exposure that they are willing to assume, the average duration
of their investment holding period, and the market capitalizations
of targeted companies.
more diversified approach.
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4. Hedge Fund Portfolio Soutions for Advisors
Drivers of Returns
The returns of long/short equity managers are determined by
source of alpha would seek out individual names deemed to be
the skill of the manager and their ability to successfully navigate
overvalued in the sector and subsequently implement a short
the market. By and large, long/short equity managers rely on
position with the goal of producing a return that outperforms the
their stock picking expertise and hedging ability to generate
index and, thereby, enhances the manager’s spread.
returns.
Consequently, the ability to extract alpha on the short side re-
Success within the space generally hinges on the ability to cor-
quires a particular skillset and is the hallmark of a leading long/
rectly predict companies that will outperform the market while
short equity manager.
also discerning the underperformers and shorting them.
While an overriding factor, stock selection is not the sole driver
The difference between the returns of the long and short hold-
of long-term returns for long/short equity managers. Managers
ings is referred to as a “spread” and managers who are able to
pursuing the long/short equity strategy have the ability to aug-
maximize a positive spread offer a more attractive return profile.
ment returns by actively managing the levels of gross and net
The ability of long/short equity managers to deliver a positive
exposure in the portfolio.
spread is largely related to how they utilize their short portfo-
Gross exposure is defined as the long portfolio plus the absolute
lio. A long/short equity manager who mostly employs market
value of the short portfolio whereas net exposure equals the dif-
hedges in their short portfolio is not taking full advantage of the
ference between the long portfolio and the short portfolio.
opportunity to extract double alpha.
A long/short equity manager who has the foresight to reduce
For instance, at the most basic level, a manager that estab-
exposure levels before a market correction is able to protect
lishes a short position in an ETF related to U.S. regional banks
investor capital and offer an attractive means to long term cap-
to hedge a long holding in the sector is largely focused on at-
ital appreciation. Conversely, managers who seek to expose
tempting to reduce sector risks in the name in order to isolate
themselves to more market directionality would increase their
company specific factors as a source of return. Alternatively, a
exposures.
long/short equity manager who views their short portfolio as a
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5. Hedge Fund Portfolio Soutions for Advisors
The Advantages of
Long/Short Equity Funds
Better Risk-adjusted Returns than Traditional Equity Portfolios
Over the past 10 years, long/short equity strategy hedge funds have been able to outperform the S&P 500 with significantly less volatility.
As illustrated in the chart below, the CS Equity Long/Short HF Index delivered over 100 basis points of outperformance with a standard
deviation of 7.84% versus 14.50% for the S&P 500. This translates into a Sharpe Ratio of 0.78 for the CS Long/Short Equity HF Index
compared to 0.41 for the S&P 500.
Annualized ROR
7.67%
Std. Deviation
7.84%
Cumulative Value
222.62
199.66
66.92%
-21.97%
14.50%
6.59%
% Months Positive
Max Drawdown
63.85%
-52.56%
Sharpe Ratio
Correl to S&P 500
Sortino
0.37
0.78
0.81
0.41
Credit Suisse Long/Short Equity HF Index
0.12
NA
Jan. 2003 – Oct. 2013
S&P 500 Index
Potential downside protection in major downturns
It is important to note that long/short equity managers generally run
with a low-to-moderate amount of net exposure to equity markets. As a
CS Equity
Long/Short Performance
Index
Differential
Period
S&P 500
Q4-2008
-22.55%
-7.47%
15.08%
periods when equity markets faced significant headwinds, the strategy
Q3-2002
-17.63%
-2.43%
15.20%
has been able to offer considerable downside protection.
Q3-2001
-14.98%
-1.84%
13.14%
Q3-2011
-14.33%
-9.80%
4.53%
Long/Short HF Index has historically outperformed the S&P 500 by an
Q2-2002
-13.74%
0.14%
13.87%
average of 9.54% during the 10 worst quarters for the equity markets
Q1-2001
-12.12%
-4.87%
7.25%
as long/short equity funds returned on average -4.37% versus -13.91%
Q2-2010
-11.86%
-5.84%
6.02%
result of operating a hedged portfolio, long/short equity managers typically have not fully participated in runaway bull markets. However, in
For instance, as demonstrated in the table to the right, the CS Equity
for the S&P 500.
Q1-2009
-11.67%
0.32%
11.99%
This ability to offer protection during equity market downturns has
Q3-1998
-10.30%
-7.80%
2.50%
resulted in more attractive risk-adjusted returns and a superior cumula-
Q1-2008
-9.93%
-4.09%
5.84%
Average
-13.91%
-4.37%
9.54%
tive growth for the strategy.
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7. Hedge Fund Portfolio Soutions for Advisors
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