What is Gross Exposure
Gross exposure refers to the absolute level of a fund's investments. Gross exposure equals the value of both a fund’s long positions and short positions and can be expressed either in dollar terms or percentage terms. It is a measure that indicates total exposure to financial markets, thus providing an insight into the investment amount at risk. The higher the gross exposure, the bigger the potential loss (or gain).
BREAKING DOWN Gross Exposure
Gross exposure is an especially relevant metric in the context of hedge funds, institutional investors, and other traders, who can hold short positions, in addition to long positions. These types of investors are sometimes more sophisticated and have greater resources than long-only investors.
As an example, consider hedge fund A with $200 million in capital. It deploys $150 million in long positions and $50 million in short positions. The fund's gross exposure is thus: $150 million + $50 million = $200 million.
Since gross exposure equals capital in this case, gross exposure as a percentage of capital is 100%.
The net exposure, which is the difference between long and short positions = $150 million - $50 million = $100 million.
Assume hedge fund B also has $200 million in capital but uses a significant amount of leverage. As a result, it has $350 million in long positions and $150 million in short positions. The gross exposure in this case is thus $500 million (i.e. $350 million + $150 million), while the net exposure is $200 million (i.e. $350 - $150 million).
Gross exposure as a percentage of capital for hedge fund B = $500 million ÷ $200 million = 250%.
Fund B's higher gross exposure means that it has a greater amount at stake in the markets than A. Fund B's use of leverage will magnify losses, as well as profits.
Gross Exposure and The Calculation of Management Fees
Gross exposure is generally used as the basis for calculating a fund's management fees, since it takes into account total exposure of investment decisions on both the long and short side. Portfolio managers combined decisions will have direct consequences on the performance of a fund and thus distributions to its investors.
An additional method of calculating exposure is a beta-adjusted exposure, also used for investment funds or portfolios. This is computed by taking the weighted average exposure of a portfolio of investments, where the weight is defined as the beta of each individual security.