What Is A Long Short Strategy

[Young Vadlapatla]

As market volatility continues due to inflation, Central Bank policy, and other concerns, investors may be seeking ways to add resiliency to their portfolios. It could therefore be an opportune time to consider the inherently risk-mitigating characteristics of long-short equity strategies.

As the name suggests, long-short equity strategies invest both long and short in publicly traded equities and equity-related instruments. Compared to their long-only counterparts, long-short strategies are designed to have lower sensitivity to equity market movements, as measured by beta, volatility and drawdowns. When included as part of a broadly diversified portfolio, such strategies have the potential to: (1) generate profits from their long and short positions and (2) provide an element of risk mitigation, or hedge, when markets decline because gains on short positions will dampen losses on long positions.

In addition to the potentially risk-mitigating benefits of including short positions, long-short strategies typically have flexibility to adjust their risk profiles in response to changing market conditions. They are not required to maintain static exposures, nor are they tethered to a benchmark. Managers of market-neutral strategies can take a variety of steps to reduce risk and protect capital, specifically:

Among long-short equity strategies, market-neutral strategies have proven particularly adept at managing downside risk over time, while allowing investors to participate in up markets as well (Displays 3 and 4).

These are unprecedented times, and investors are likely looking for ways to increase the resiliency of their portfolios. In our view, including an allocation to market-neutral strategies in a well-balanced portfolio could provide valuable downside risk-mitigating benefits.

Short interest ratio: A formula that represents the average number of days it takes short sellers to cover their positions, or repurchase the shares they have borrowed. This ratio indicates whether a stock is heavily shorted or not shorted versus its average daily trading volume.

MSCI World Index Net (USD): A market cap weighted stock market index that represents large and mid-cap equity performance across 23 developed markets countries with net dividends reinvested in US dollars.

HFRI EH: Equity Market Neutral Index: Equity Market Neutral strategies employ sophisticated quantitative techniques of analyzing price data to ascertain information about future price movement and relationships between securities, select securities for purchase and sale. These can include both Factor-based and Statistical Arbitrage/Trading strategies. Factor-based investment strategies include strategies in which the investment thesis is predicated on the systematic analysis of common relationships between securities. In many but not all cases, portfolios are constructed to be neutral to one or multiple variables, such as broader equity markets in dollar or beta terms, and leverage is frequently employed to enhance the return profile of the positions identified. Statistical Arbitrage/Trading strategies consist of strategies in which the investment thesis is predicated on exploiting pricing anomalies which may occur as a function of expected mean reversion inherent in security prices; high frequency techniques may be employed and trading strategies may also be employed on the basis on technical analysis or opportunistically to exploit new information the investment manager believes has not been fully, completely or accurately discounted into current security prices. Equity Market Neutral Strategies typically maintain characteristic net equity market exposure no greater than 10% long or short.

HFRI Equity Hedge (Total) Index: Investment Managers who maintain positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios. EH managers would typically maintain at least 50% exposure to, and may in some cases be entirely invested in, equities, both long and short.

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Global Pandemics. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (such as natural disasters, epidemics and pandemics, terrorism, conflicts and social unrest) that affect markets generally, as well as those that affect particular regions, countries, industries, companies or governments. It is difficult to predict when events may occur, the effects they may have (e.g. adversely affect the liquidity of the portfolio), and the duration of those effects.

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A separately managed account may not be suitable for all investors. Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing. A minimum asset level is required. For important information about the investment manager, please refer to Form ADV Part 2.

Separate accounts managed according to the Strategy include a number of securities and will not necessarily track the performance of any index. Please consider the investment objectives, risks and fees of the Strategy carefully before investing.

The views and opinions are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment teams at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in all the strategies and products that the Firm offers.

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This material is a general communication, which is not impartial and has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. All investments involve risks, including the possible loss of principal. The information herein has not been based on a consideration of any individual investor circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

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