As you may have seen recently, a Japanese amusement park asked patrons to stop screaming on roller coasters in an attempt to contain the spread of COVID-19. For me, I know that would be an impossibility since I scare easily, and so I was impressed when I watched the video of well-dressed riders barely reacting at all.
While not an actual roller coaster, the markets have been quite a ride themselves this year with the MSCI World Index seeing a peak to trough drop of -31.82% in Q1, and an aggressive recovery up 38.22% through June 30th. Depending on how closely investors watch the markets or their portfolios, they may have been screaming a bit themselves.
2020 has almost mirrored the 2008-2009 financial crisis in just six short months; it has also provided a microcosm of the way long/short equity funds operate— specifically how they can smooth out the inevitable ups and downs in the market.
While the category lagged the aggressive recovery in Q2 (up 8.26% vs. global stocks up 19.36%), it successfully protected capital during the sell-off in the first quarter. Even with the recent lag, the category is still outperforming global stocks, as of the end of the second quarter (-4.50% vs. -5.77%).
This is the overall promise of long/short equity funds. They expect to lag in aggressively rising markets, aim to protect in down markets, and seek to participate in moderate markets so that at the end of it all you achieve the same or better return with lower volatility on an annualized basis—but in actuality you end up ahead on a compounded basis driven by the lower downside participation.
Long/Short Equity in Down and Choppy Markets
The question now is: What part of this current ride are we on? Are we heading toward the next big drop? Are we going to continue climbing, or will we be getting more into a choppy but ultimately flat part of the track? No matter what comes next, long/short equity is a strategy that can help smooth out that ride and hopefully protect investors from excessive screaming.
Read more in Q&A with Blaine: 2020 Market Mid-Year Review >