This content is from: Portfolio

Hedge Fund Investors Seek Safety in Long-Short Equity

With markets unpredictable at best, a recent survey has found that hedge fund investors have been seeking safety lately in long-short equity investments.

Hedge fund investors are warming up to long-short equity.

We saw the first hint of this growing trend back in late fall when a Preqin survey of institutional investors found that 38 percent of responders were seeking long-short equity investments, making it the most popular strategy. “The strategy’s continued popularity is due to its ability to provide a level of protection in falling markets while capturing the majority of the upside in rising markets,” the London-based expert on alternative investments noted in its report at the time.

This sentiment was further confirmed earlier this week in a 30-page report published by PerTrac, a provider of software for investment professionals, which found that long-short equity is the most popular strategy pursued by Alternative UCITS (Undertakings for Collective Investment in Transferable Securities) funds. Alternative UCITS funds are those fast-growing, pan-European investment vehicles that pursue hedge-fund-like strategies but with limited leverage and illiquid assets.  

As of October 2011 long-short equity funds and fixed-income funds both exceeded €30 billion, or about $40 billion, accounting for slightly more than 40 percent of the industry’s total assets under management, according to the PerTrac report.

“We have increased our bets on long-short equity,” confirms Charles Stucke, managing director and chief investment officer of the wealth management practice of Guggenheim Partners, a financial services firm with more than $125 billion in assets under management. He says he started moving more aggressively into the strategy about a year and a half ago.

Until now macro has been the strategy of choice among many hedge fund investors. Hedge Fund Research, which publishes monthly hedge fund data, recently reported that macro hedge funds enjoyed net inflows of $7.9 billion in the fourth quarter and $27.9 billion for all of 2011.

But many of the largest macro funds posted mediocre results last year.

Investors have been shunning long-short funds since many of the funds blew up with the rest of the equity markets in 2008. Since then they have suffered from a high level of correlation and low dispersion of results. In other words, many of them performed similarly in a range from mediocre to lousy.

Also, many long-short shops are really long-only funds that merely dabble in shorting.

“We’ve seen unprecedented correlations, extreme levels of intramonth volatility, and fundamentals have fallen to the wayside,” points out Rick Teisch, director of research for Liongate Capital Management, a fund-of-hedge-funds firm with $3 billion in assets. He says he has had a less-than-10-percent long-short allocation for some time and prefers funds that maintain low net exposure and have strong capabilities on both the long and short sides.

Last year, for example, the market took a big beating in August and September, only to surge more than 15 percent in October, plummet in November and then rally in the final days of the year — not an easy environment in which to make money for any strategy. 

As a result, long-short equity funds, on average, lost 3 percent in 2011, making it the second-worst-performing group, according to a new study published by John Dyment, UBS global head of hedge fund distribution.

A number of the more celebrated long-short managers suffered double-digit losses in 2011, including Lee Ainslie’s Maverick Capital, which lost nearly 15 percent; Mark Kingdon’s M. Kingdon Offshore, which fell 18 percent; and Highbridge Long-Short Equity fund, which ended the year down 12.63 percent, according to HSBC.

Stucke is confident that after three or four years, the style will revert to the mean. This notion is based in part on his belief that over the long term, markets, in general, are rational.

He says that because uncertainties have been removed from the market, such as political debates in the U.S. over the budget and the European banking crisis, investors eyes should turn away from the drama in the macro environment. As a result, investors will look more at the fundamentals of underlying stocks rather than decide whether or not to put more or less risk into the market depending upon the headlines coming out of Washington or Europe.

This means the environment will be more conducive to rewarding stock pickers, both on the long and short side.

Related Content