Nearly two years ago, we wrote about the increasing beta we saw in many Long/Short Equity funds and the potential downside it could cause if markets were to stop their upward trajectory. At the time of that writing, we were smack in the middle of a record bull market run and it likely wasn’t a concern to many readers. A few months later, in late 2018 we did see some volatility, but by the time anyone noticed, markets shot higher (in early 2019) and strategies with higher beta continued to outperform those that were less sensitive to overall market movements.
After the turbulent few weeks we’ve recently experienced in markets, we thought it was a good time to revisit the blog. Contrary to 2018, what we have seen in this most recent drawdown, is that strategies that previously had been outperforming in the category are suddenly capturing a significant amount of the downside—thus not providing the protection investors may have hoped for. In our view, long/short funds are not meant to match long only equities in rising markets, but they are meant to protect capital in down markets.
At the time of the original post, we were concerned with the level of market sensitivity many of these funds had and hoped investors would look beyond top-line performance to fully understand how much market risk was in the strategy. We think it is even more important now. While it is unlikely we will see another 18% plus move down, it is potentially more likely we experience flat or volatile markets. Those are environments in which it is valuable to have a strategy in place that does not rely so much on market exposure, but can generate alpha and has a disproportionate upside/downside capture so it can benefit from choppiness. We think it is a good time to evaluate current strategies, or if it is an area of consideration, investors assess the levels of beta (not just performance) and make sure it is at a level they are comfortable maintaining in a potentially more difficult period for equities.
Read the blog here, The (Really) Long and the Short of It >