What Is a Long/Short Fund?
A long/short fund is a type of mutual fund or hedge fund that takes both long and short positions in investments typically from a specific market segment. These funds often use several alternative investing techniques such as leverage, derivatives, and short positions to purchases relatively undervalued securities and sell overvalued ones.
Long/short funds may also be referred to as enhanced funds or 130/30 funds.
- Long/short funds use an investment strategy that seeks to take a long position in underpriced stocks while selling short overpriced shares.
- Long/short seeks to augment traditional long-only investing by taking advantage of profit opportunities from securities identified as both under-valued and over-valued.
- Long/short equity is commonly used by hedge funds, which often take a relative long bias—for instance, a 130/30 strategy where long exposure is 130% of AUM and 30% is short exposure.
The Basics of a Long/Short Fund
Long/short funds typically seek to enhance the returns from investing in a specific market segment by actively taking both long and short positions in securities. Long/short funds use varying active management techniques to determine portfolio holdings. They may also use leverage, derivatives, and short positions which can increase the risks of the fund as well as the fund’s potential total return.
Long/short funds represent some similarities to hedge funds. They seek to offer investment strategies with greater risk and greater return potential over standard benchmarks. Most long/short funds feature higher liquidity than hedge funds, no lock-in periods, and lower fees. However, they still have higher fees and less liquidity than most mutual funds. Long/short funds also may require higher minimum investments than other mutual funds. Long/short funds are more closely regulated than hedge funds therefore they have limitations on the use of leverage and derivatives where hedge funds do not.
Long/short funds can be a good investment for investors seeking targeted index exposure with some active management. Long/short funds also offer the advantage of hedging against changing market environments and other trends that active management can account for.
Understanding the 130-30 Strategy
The most common long/short strategy is to be long 130% and short 30% (130 - 30 = 100%) of assets under management. To engage in a 130-30 strategy, an investment manager might rank the stocks used in the S&P 500 from best to worse on expected return, as signaled by past performance. A manager will use a number of data sources and rules for ranking individual stocks. Typically stocks are ranked according to selection criteria (for example, total returns, risk-adjusted performance, or relative strength) over a designated look-back period of six months or one year. The stocks are then ranked best to worst.
From the best ranking stocks, the manager would invest 100% of the portfolio's value and short sell the bottom ranking stocks, up to 30% of the portfolio's value. The cash earned from the short sales would be reinvested into top-ranking stocks, allowing for greater exposure to the higher-ranking stocks.
Examples of Long/Short Funds
The performance of long/short funds, like any hedge fund, will vary from year to year, and the best funds in one year may lag in another. ICON and RiverPark are two of the top-performing long/short funds in 2017, but they lagged behind their peers in 2020. Still, they provide a good insight into what long/short funds do.
ICON Long/Short Fund
The ICON Long/Short fund had year to date performance of 25.96% as of Dec. 1, 2017. The fund’s investable universe includes all equity securities traded in the U.S. market. It uses the S&P 1500 Index as its benchmark. The fund uses quantitative analysis to identify undervalued and overvalued securities in the investment universe. It then takes long positions in stocks it believes to be undervalued and short positions in stocks it believes to be overvalued.
RiverPark Long/Short Opportunity Fund
The RiverPark Long/Short Opportunity Fund is another top-performing fund in the category. Year to date as of Dec. 1, 2017, the Fund had a return of 24.07%. The Fund uses a proprietary investment process for identifying undervalued and overvalued securities. It also has a transparent framework for its portfolio holdings. The Fund invests in U.S. equities across all market capitalizations and may also invest in foreign equities. It seeks to buy undervalued companies and take short positions on overvalued companies. It generally holds 40 to 60 long positions and 40 to 75 short positions.