Finding “The Masters” of Long/Short Equity

It’s Masters week… one of the most historic and watched sporting events in the world. The game of golf is a complex sport, and Tiger, Phil, Jordan, and crew work tirelessly to understand and overcome the challenges of the game. This is done with patience, process and study to get the best performance out of each swing. As I sit and watch these guys try to read every little nuance of the green (break, speed, grain, etc.) before hitting their putts, I’m reminded of the painstaking due diligence process investment professionals go through when selecting a manager, especially in a more complex category like Long/Short Equity. With wide dispersion among Long/Short Equity managers, it’s critical that due diligence processes are thorough. To help in your manager selection process, we’ve listed several points of consideration below.

    • Size is the enemy. As with any active investment strategy, when too many assets are raised, it is harder to put those assets to work without lowering the strategy’s return potential.

 

    • The purpose of the short portfolio matters greatly. Some strategies use the short side of the portfolio as a source of alpha. If so, the manager should demonstrate a history of adding value through shorting stocks. Other managers use the short portfolio as an equity market hedge. If this is the case, the manager should be adding value by varying the net exposure to equities over time, not simply maintaining a static hedge, which doesn’t add any value.

 

    • Shorting stocks successfully takes experience. The ability to short stocks more fully utilizes a manager’s stock research and screening processes. However, shorting stocks is new for many managers and it’s not as simple as finding overvalued stocks. Fiduciaries should consider the investment team’s experience in shorting.

 

  • The long portfolio matters too. Alpha may be generated by the short side, but the long side will generate the lion’s share of the returns over time. Ensure the manager actually has skill.

We believe the need for Long/Short Equity strategies may be greater today than it’s been in decades due to rich valuations, the age of the bull market, and the return of volatility. And just like at the Masters, those who take the time to fully understand the nuances of each investment can end up wearing the proverbial green jacket at the end of the day.

For additional tips to help you find the right manager for your allocations, please read our Long/Short Equity Manager Due Diligence Checklist >