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Long/short equity is an investment strategy [1] generally associated with hedge funds. It involves buying equities that are expected to increase in value and selling short equities that are expected to decrease in value. This is different from the risk reversal strategies where investors will simultaneously buy a call option and sell a put option to simulate being long in a stock.
Typically, equity long/short investing is based on "bottom up" fundamental analysis of the individual companies, in which investments are made. There may also be "top down" analysis of the risks and opportunities offered by industries, sectors, countries, and the macroeconomic situation.
Long/short covers a wide variety of strategies. There are generalists, and managers who focus on certain industries and sectors or certain regions. Managers may specialize in a category — for example, large cap or small cap, value or growth. There are many trading styles, with frequent or dynamic traders and some longer-term investors.
A fund manager typically attempts to reduce volatility by either diversifying or hedging positions across individual regions, industries, sectors and market capitalization bands and hedging against un-diversifiable risk such as market risk. In addition to being required of the portfolio as a whole, neutrality may in addition be required for individual regions, industries, sectors, and market capitalization bands.
There is wide variation in the degree to which managers prioritize seeking high returns, which may involve concentrated and leveraged portfolios, and seeking low volatility, which involves more diversification and hedging.
This is in addition to market neutral strategy, as it adds a permanent stock index futures overlay, which makes profit or losses, depending on the movement of the market. Your portfolio then has a full equity market exposure.
A hedge fund might sell short one automobile industry stock, while buying another—for example, short $1 million of DaimlerChrysler, long $1 million of Ford. With this position, any event that causes all auto industry stocks to fall will cause a profit on the DaimlerChrysler position and a matching loss on the Ford position. Similarly, events that cause both stocks to rise—for example a rise in the market as a whole—will have little or no effect on the position.
Presumably the hedge fund has sold DaimlerChrysler and bought Ford because the manager expects Ford to perform better. If the manager is correct, the fund should profit irrespective of market and sector moves.
Market neutral strategies can be seen as the limiting case of equity long/short, in which the long and short portfolios of the fund are balanced with great care so that a very high degree of hedging is achieved. Some advantages of market neutral strategies include being able to generate positive returns in a down market, and generating returns with a lower volatility profile.
"Market neutrality" refers to hedging out market risk, which can be managed through the use of derivatives, such as futures on market indexes. Market neutral funds usually seek to hedge against most or all predictable risk exposures.
An extension on the market neutral strategy is the factor neutral strategy. The factor neutral strategy is neutral on market risk, as well as major factors like momentum and large cap vs small cap. This is a step towards more modern capital market models like the Fama–French three-factor model.
There are many difficulties with managing long/short funds. These include the difficulties of estimating and hedging the risks to which a portfolio is exposed, and the requirement to manage unsuccessful short positions in an active manner. Short positions that are losing money grow to become an increasingly large part of the portfolio, and their price can increase without limit.
To make money, the hedge fund must successfully predict which stocks will perform better. It requires making intelligent use of the available information, but this is not enough—it also requires making better use of the available information than large numbers of capable investors. This strategy is primarily implemented by hedge funds and sophisticated institutions.
A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as short selling, leverage, and derivatives. Financial regulators generally restrict hedge fund marketing to institutional investors, high net worth individuals, and others who are considered sufficiently sophisticated.
Passive management is an investing strategy that tracks a market-weighted index or portfolio. Passive management is most common on the equity market, where index funds track a stock market index, but it is becoming more common in other investment types, including bonds, commodities and hedge funds.
A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, gambles, many types of over-the-counter and derivative products, and futures contracts.
An exchange-traded fund (ETF) is a type of investment fund and exchange-traded product, i.e. they are traded on stock exchanges. ETFs are similar in many ways to mutual funds, except that ETFs are bought and sold from other owners throughout the day on stock exchanges whereas mutual funds are bought and sold from the issuer based on their price at day's end. An ETF holds assets such as stocks, bonds, currencies, futures contracts, and/or commodities such as gold bars, and generally operates with an arbitrage mechanism designed to keep it trading close to its net asset value, although deviations can occasionally occur. Most ETFs are index funds: that is, they hold the same securities in the same proportions as a certain stock market index or bond market index. The most popular ETFs in the U.S. replicate the S&P 500 Index, the total market index, the NASDAQ-100 index, the price of gold, the "growth" stocks in the Russell 1000 Index, or the index of the largest technology companies. With the exception of non-transparent actively managed ETFs, in most cases, the list of stocks that each ETF owns, as well as their weightings, is posted daily on the website of the issuer. The largest ETFs have annual fees of 0.03% of the amount invested, or even lower, although specialty ETFs can have annual fees well in excess of 1% of the amount invested. These fees are paid to the ETF issuer out of dividends received from the underlying holdings or from selling assets.
In finance, statistical arbitrage is a class of short-term financial trading strategies that employ mean reversion models involving broadly diversified portfolios of securities held for short periods of time. These strategies are supported by substantial mathematical, computational, and trading platforms.
Convertible arbitrage is a market-neutral investment strategy often employed by hedge funds. It involves the simultaneous purchase of convertible securities and the short sale of the same issuer's common stock.
Investment management is the professional asset management of various securities, including shareholdings, bonds, and other assets, such as real estate, in order to meet specified investment goals for the benefit of investors. Investors may be institutions, such as insurance companies, pension funds, corporations, charities, educational establishments, or private investors, either directly via investment contracts or, more commonly, via collective investment schemes like mutual funds, exchange-traded funds, or REITs.
Active management is an approach to investing. In an actively managed portfolio of investments, the investor selects the investments that make up the portfolio. Active management is often compared to passive management or index investing.
In finance, an investment strategy is a set of rules, behaviors or procedures, designed to guide an investor's selection of an investment portfolio. Individuals have different profit objectives, and their individual skills make different tactics and strategies appropriate. Some choices involve a tradeoff between risk and return. Most investors fall somewhere in between, accepting some risk for the expectation of higher returns.
Asset allocation is the implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investor's risk tolerance, goals and investment time frame. The focus is on the characteristics of the overall portfolio. Such a strategy contrasts with an approach that focuses on individual assets.
In finance, an asset class is a group of financial instruments that have similar financial characteristics and behave similarly in the marketplace. We can often break these instruments into those having to do with real assets and those having to do with financial assets. Often, assets within the same asset class are subject to the same laws and regulations; however, this is not always true. For instance, futures on an asset are often considered part of the same asset class as the underlying instrument but are subject to different regulations than the underlying instrument.
An investment strategy or portfolio is considered market-neutral if it seeks to avoid some form of market risk entirely, typically by hedging. To evaluate market-neutrality requires specifying the risk to avoid. For example, convertible arbitrage attempts to fully hedge fluctuations in the price of the underlying common stock. A portfolio is truly market-neutral if it exhibits zero correlation with the unwanted source of risk. Market neutrality is an ideal, which is seldom possible in practice. A portfolio that appears market-neutral may exhibit unexpected correlations as market conditions change. The risk of this occurring is called basis risk.
Style investing is an investment approach in which securities are grouped into categories and portfolio allocation based on selection among styles rather than among individual securities. Style investors can make portfolio allocation decisions by placing their money in broad categories of assets, such as small-cap, value, low-volatility, or emerging markets. Some investors dynamically allocate across different styles and move funds back and forth between these styles depending on their expected performance.
Core & Satellite Portfolio Management is an investment strategy that incorporates traditional fixed-income and equity-based securities known as the "core" portion of the portfolio, with a percentage of selected individual securities in the fixed-income and equity-based side of the portfolio known as the "satellite" portion.
Alternative beta is the concept of managing volatile "alternative investments", often through the use of hedge funds. Alternative beta is often also referred to as "alternative risk premia".
A 130–30 fund or a ratio up to 150/50 is a type of collective investment vehicle, often a type of specialty mutual fund, but which allows the fund manager simultaneously to hold both long and short positions on different equities in the fund. Traditionally, mutual funds were long-only investments. 130–30 funds are a fast-growing segment of the financial industry; they should be available both as traditional mutual funds, and as exchange-traded funds (ETFs). While this type of investment has existed for a while in the hedge fund industry, its availability for retail investors is relatively new.
Global Tactical Asset Allocation, or GTAA, is a top-down investment strategy that attempts to exploit short-term mis-pricings among a global set of assets. The strategy focuses on general movements in the market rather than on performance of individual securities.
In finance, a stock index, or stock market index, is an index that measures a stock market, or a subset of the stock market, that helps investors compare current stock price levels with past prices to calculate market performance.
A quantitative fund is an investment fund that uses quantitative investment management instead of fundamental human analysis.
A managed futures account (MFA) or managed futures fund (MFF) is a type of alternative investment in the US in which trading in the futures markets is managed by another person or entity, rather than the fund's owner. Managed futures accounts include, but are not limited to, commodity pools. These funds are operated by commodity trading advisors (CTAs) or commodity pool operators (CPOs), who are generally regulated in the United States by the Commodity Futures Trading Commission and the National Futures Association. As of June 2016, the assets under management held by managed futures accounts totaled $340 billion.
Singh, Laurie Kaplan (2001), "Keeping It Clean", Institutional Investor Magazine
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