What is a long-short mutual fund?

Mutual Funds
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Long-Short Mutual funds can be a beneficial piece of your portfolio, if you are the stage in life where you are looking for less volatility or you're generally worried about the future of the equity markets.  As mentioned in previous posts, long/short funds are picking investments to buy (long) and investments to sell (short).  This does not have to be individual securities, as long/short managers can short large markets or even sectors they believe are out of favor.  The purpose of adding a long/short fund to your portfolio is diversification through low correlation.  In other words, you are looking for a fund that will zig when the market zags.  Correlation doesn't have to be negative, because you want to still make money when the market is going up, but you want a fund with the flexibility to take risk off the table or even make money when equities are falling.  As such, the returns will not look anything like the S&P 500 and should be evaluated over a 5 - 10 year period.  

In our firm, we have a couple of different long/short funds that we use.  For those investors looking to take more risk we use one with a higher standard deviation closer to 10.  For those clients that are moderate risk, we use a different long/short fund with a standard deviation closer to 4.5.  These numbers are important when you are deciding how much risk to allocation to an alternative strategy like long/short funds.  Furthermore, since these funds are actively managed you need the ability to see how much bang you're getting for your buck.  Using Morningstar you should be able to find the Treynor Ratio which is a measure of risk-adjusted return.  You can use a Sharpe Ratio as well, although Sharpe Ratio is usually used to value the risk-adjusted return of an entire portfolio and not just a single manager.  Given the higher fees you want to make sure you are being provided a positive risk-adjusted return.  To learn more about the Treynor Ratio click here to view an article from US News & World Report.

If you are a young investor and just getting started, then a long/short fund is not necessary.  Take advantage of dollar cost averaging and buy low cost investments.  If you're getting close to retirement or are in retirement then these types of investments can have value.  Be sure to evaluate a fund with a long enough track record to see how well they have performed in various market conditions.  As these funds are successful they eventually reach capacity and close to the public, but check with your advisor if they have access to some they would suggest.

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