The long-short equity strategy is a portfolio management technique in which the manager tries to reduce the amount of market risk by using both long and short positions in the portfolio. The reasoning is that if the market goes down and the long positions suffer losses, the short positions will offer profits, which will help reduce total losses and ensure that the portfolio continues to show a profit. Let's go through the ins and outs of the long-short equities strategy and how you may incorporate it into your investment plan.
Definition of a Long-Short Equity Strategy
The long-short equity strategy is an investment technique utilised mostly by managers of hedge and mutual funds. With this strategy, managers buy stocks that they believe will increase in price and sell short stocks that they believe will decrease in price. When an investor engages in short, they are attempting to benefit from a fall in the value of a stock. They can do this by first selling a stock that they borrowed via a margin account and then, after the stock's price has dropped, purchasing it back to refund to the lender.
Because it has long and short positions, the fund has the potential to generate money regardless of whether the market is rising or falling. Hedging is another term for aiming to produce profits regardless of market circumstances. Another term for this concept is the absolute return investment strategy.
In general, the goal of investment managers is to find companies that are inexpensive to purchase and those that are overpriced to short. The portfolio has the potential to earn a profit over the long run if the cheap companies continue to rise in value. In contrast, the overvalued equities continue to fall in value. The BlackRock Global Long/Short Equity Fund is an example of a fund that uses a long-short equities strategy. BlackRock offers this fund, which is also an example of a company that uses a long-short equity strategy.
How a Long-Short Equity Strategy Works
The long-short approach was first used in hedge funds and has since found its way into mutual fund management. Individual traders have a lower incidence of this problem. Let's look at some real-world applications of the tactic to see how it works.
For instance, BlackRock provides investors access to a long-short equity fund known as The BlackRock Global Long/Short Equity Fund. Using standard fundamental research, this fund chooses long and short positions in global stocks. The fund's goal is to reduce exposure to market risk via diversification. Another example of this would be the Guggenheim Long Short Equity fund. Like many other hedge funds, this fund uses leverage to magnify gains.
It takes long and short positions across various market segments, including utilities, financials, consumers, and real estate. The long-short equity strategy, known as the 130-30 equity strategy, is one that hedge funds often utilise. This strategy gives preference to long holdings. The fund allocates 130% of its total capital to long positions, while the remaining 30% is invested in short positions.
What It Means for Individual Investors
A long-short equity strategy provides several potential benefits as well as potential drawbacks. Investors may construct a less connected portfolio with market fluctuations by using a mix of long and short strategies in an appropriate proportion. Therefore, they have the potential to achieve profits that are superior to those of the whole market.
Individual investors contemplating long-short equity funds should be aware that the costs associated with these products are often higher than those associated with a typical mutual fund. Naturally, increased fees will affect the money you make. According to Vanguard, the average cost ratio for mutual funds is around 0.54%, while the Guggenheim Long Short Equity fund has a gross expense ratio of 1.75%. This is much higher than the industry average of 0.54%. (which did not include its funds). The increased expense ratio associated with many long-short funds may be partially attributed to the greater expenses incurred as a result of leverage, shorting, and more frequent trading in the funds.
Requirements For Long-Short Mutual Funds
However, the admission requirements for long-short mutual funds are far lower than those for hedge funds, which may go as high as $100,000 or more. On the other hand, long-short mutual funds often have minimum investment requirements of less than $1,000. Finally, experienced individual investors may try their hand at their version of a long-short strategy by engaging in pairs trading; however, it is important to remember that this is a sophisticated trading approach. The act of simultaneously buying and selling shares of a single company that operates within the same market or industry is known as pairs trading. In this approach, a decline in the market would affect both holdings.
