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Posted by on Aug 6, 2013 in AdvisorShares, Investment Perspective

Thoughts on the Long/Short Space

Thoughts on the Long/Short Space

The following insight from Kurt Voldeng, CAIA, Chief Operating Officer of Commerce Asset Management and portfolio manager of the AdvisorShares QAM Equity Hedge ETF (QEH), highlights performance in the long/short fund universe.

The long/short equity hedge fund universe is typically 40%-65% net long in aggregate.  While market neutral managers may be included in this very broad universe, so are managers with:

  • higher than 65% net exposure
  • a focus on regions or countries outside of the U.S.
  • sector specific focus (i.e. technology, healthcare, consumer, etc.)
  • style biases (i.e. value or growth)
  • market capitalization biases

Long/short equity hedge funds thrive through security selection where a spread is earned with longs outperforming shorts.  If done properly, longs will outperform shorts and positive alpha can be generated. The returns will be higher than the net exposure return in up markets, and down less than the net exposure return in down markets. For example, a 50% net exposure manager gains more than 5% in an up 10% market and does better than losing 5% in a down 10% market.

For such an analysis, comparing apples to apples is very important to ensure that the manager is investing in a market that is the same as the index.  Long/short equity hedge funds can experience difficulty when correlations among stocks are very high and there is little differentiation in stock performance. Remember, hedge funds need to earn a positive spread between their longs and shorts to provide alpha.

Since the beginning of the financial crisis, most equity market returns have been dominated by macro forces with correlations among stocks going to historical highs and staying there.  These returns have just recently started to come down to reasonable levels. The current earnings season has already showed many examples of stocks being rewarded for good performance and punished for poor performance.   This is a good sign of correlations breaking down and favoring an environment where long/short equity hedge funds may be able to once again prove their worth in investors’ portfolios.

Remember, for hedge fund investors, it is a long-term race, not a sprint.