The long/short equity strategy is a type of portfolio management strategy where the manager attempts to reduce market risk by taking both long and short positions. Investing in long/short equities aims to mitigate market risk and maximize returns in the portfolio. By selling and buying stocks simultaneously, the portfolio can increase in value even in a declining market. Many mutual funds employ the long/short equity strategy, but investors should consider the higher fees associated with these funds.
Definition and Examples of the Long/Short Equity Strategy
The long/short equity strategy is an investment approach primarily used by alternative investment funds or mutual fund managers to buy stocks they expect to rise and sell stocks they expect to fall. Through short selling, the investor aims to profit when the stock price falls. This can be achieved by selling a borrowed share in a margin account, then repurchasing it after the price drops to return it to the lender.
By using both long and short positions together, the fund can achieve profits in both bull and bear markets. This concept of attempting to profit regardless of market conditions is also referred to as absolute return or hedging strategy.
Generally, investment managers aim to select undervalued stocks to buy and overvalued stocks to sell. Over the long term, the portfolio can achieve gains if the undervalued stocks appreciate over time while the overvalued stocks depreciate.
How the Long/Short Equity Strategy Works
The long/short equity strategy originated in alternative investment funds and is now also used in mutual fund management. It is less common among individual traders. Let’s look at some examples of how this strategy works.
For instance, BlackRock offers a long/short equity fund called the BlackRock Global Long/Short Equity Fund. The firm employs traditional fundamental analysis to buy and sell stocks in developed markets. (Read more about BlackRock and other examples of long/short equity strategies below.)
Another example is the Guggenheim Long Short Equity Fund, which, like many alternative investment funds, uses leverage to amplify returns. It invests in long and short positions across several sectors, including utilities, financials, consumer goods, and real estate.
What It Means for Individual Investors
The long/short equity strategy has several advantages and disadvantages to consider. The balance of long/short equity strategies can help investors develop a portfolio that is uncorrelated with market movements, thereby providing an opportunity to achieve gains that exceed the broader market.
However, while this investment strategy can help mitigate risk, it cannot eliminate all risks. Individual investors should consider the higher fees associated with long/short equity funds, which tend to be higher than those of standard mutual funds. Higher fees, of course, can impact your profits.
For example, the Guggenheim Long Short Equity Fund has an expense ratio of 1.75%, compared to the average of about 0.54% for the mutual fund industry, according to Vanguard (which did not include its own funds).
The higher expense ratio in many long/short equity funds is partly due to the additional costs associated with leverage, short selling, and more frequent trading within the funds.
Nonetheless, long/short mutual funds typically have a lower barrier to entry compared to an alternative investment fund, which may require more than $100,000. In contrast, long/short mutual funds often require $1,000 or less to invest.
Finally
Individual investors with experience can also experiment with their own kind of long-short equity strategy by using pairs trading, although they should remember that this is an advanced trading strategy. Pairs trading is the practice of going long and short on a stock within the same industry or sector. This way, market downturns will affect both positions.
Source: https://www.thebalancemoney.com/what-is-long-short-equity-strategy-5207788
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