Strategy at a Glance
Long/Short Equity is an investment strategy designed to provide upside potential with lower volatility than a long-only portfolio. Its benefits include:
- Participation in market gains
- Capital preservation during market declines
- Portfolio diversification
A long/short equity strategy seeks to capture some of the stock market’s gains, while limiting an investor’s downside potential during market declines. To pursue this goal managers combine short and long stock positions within the portfolio. Managers can adjust total exposure to the market as needed — increasing long positions during periods of market appreciation and boosting short positions during market declines. Managers can also pursue higher returns during up markets by taking short positions in specific companies they believe are overvalued.
Growth potential: Careful stock selection with long positions allows managers to maximize potential return from the portion of the portfolio exposed to the stock market. Still, the overall upside potential of a long/short strategy may be limited by moves designed to mitigate losses.
Preservation of capital: Downside protection may limit losses during market declines and can buoy the returns of a stock portfolio, both during downturns and over a full market cycle.
The potential to profit from both winners and losers: Using both long and short positions allows managers to generate positive returns from both opportunities and challenges facing individual companies. However, investing in short positions carries its own risks, such as the risk that the price of stocks sold short may continue to appreciate and expose investors to unlimited losses.
Lower overall volatility: A long/short strategy can diversify a portfolio and dampen the impact of market swings, making it easier for investors to stick with their long-term investment strategy.
- Management teams must have experience with alternative strategies to make effective decisions about long and short positions, and to determine the appropriate overall market exposure for specific market conditions.
- Not all long/short strategies have the same goal. Some are designed to provide relatively high exposure to the market’s growth potential with only marginal downside protection, while others emphasize capital preservation over growth potential. Investors must ensure that a long/short strategy’s target market exposure meets their portfolio objectives.