Global environment exhibits VUCA (Volatility, Uncertainty, Complexity, and Ambiguity), which could continue for a while.
PMS AIF World
Though the overall growth prospects for the economy and capital markets remain high, the last 20 months have taught that stock market investing can go through frequent ups and downs with sharp moves at the sector and the stock level.
Hence, there is an opportunity on the long side, as well as the short side. This bi-directional scope for returns has led to the significant growth in the space of long short alternative investment funds which, in terms of assets, stand at around Rs 15,000 crore as of September.
The search for alternates intensify when we see the usual faltering or when the usual seems harmful. The world is gung ho about electric vehicles because the usual fossil-fuelled vehicles seem damaging to the environment.
Similarly, in the investment space, the usual investment philosophies have missed the target returns. Hence, what is catching interest among low risk investors is the long-short style of alternative investing.
The global environment exhibits VUCA (Volatility, Uncertainty, Complexity, and Ambiguity), which could continue for a while. India is undergoing strategic policy changes in the business environment. Additionally, new ways of doing business is the future, and technology developments are making older ways obsolete.
Besides, we are a tough country to run businesses with multiple regulatory risks, high costs of factors of production, heightened competition at SME/small scale business level, weak credit enforcement laws etc. All these factors are leading reasons for the volatility across stocks, sectors and industries. Thus, both long trades and short trades could be winners if the fund managers take the right call.
While all long short funds fall broadly in the same category, individual funds have different investment objectives. Some of them look to produce liquid plus returns, some look to beat Nifty with active trading and some employ levered arbitrage strategies. A few others use heavy fixed-income earnings with a trading overlay. Then, there are a few funds which run as a hedge fund where the bulk of the returns are made from equity long-short strategy without participating in market direction.
We recently conducted an interview with Harsh Agarwal, Head -Alternatives, Tata Asset Management, on the investing case for long-short funds. Harsh explained that “a diversified equity market neutral AIF strategy is popularly growing amongst HNI investors, as it is not only the lowest risk strategy within long/short investing, but is also the lowest risk equity strategy for all equity investing”.
Here, the aggregate longs (the stocks that are bought) and aggregate shorts (the stocks that are sold through futures and options, without owning them) are roughly equal in size. These are designed to exhibit nearly one-third of index volatility. Such a portfolio does not participate in market vagaries, and purely generates returns from active stock/sector selection and out-performance of long book over the short book, he added.List of popular SEBI-registered long-short funds in CAT III
Broadly, there are three risks associated with all types of long-short funds:
a) Directional trading long-short funds, which are looking to generate returns by predicting and timing the market direction, have exposed risks of fund manager’s directional calls. A trending market will favour such a strategy while range-bound or choppy markets could hurt returns.
b) Long-short funds with long bias are funds where longs are more than the shorts. These are prone to market risks where any weakness in the market hurts returns. Additionally, these are exposed to stock selection risks as these are the ones fund managers choose to buy and/or sell, and the accuracy (or lack of it) determines the returns.
c) The equity market neutral long-short funds balance the long and the short positions. Here, market direction risk (or systemic risk) is lowest, but still, the fund remains exposed to the stock selection risk, which is also the main driving factor for the fund.
Additionally, the level of concentration in the fund increases the risks and the volatility for all the above-mentioned long-short AIFs. The knack of the fund manager and the experience of the fund management team influence the performance of long-short funds. All these factors are responsible for the divergence in the performance across various types of long-short funds.
(PMS AIF World is an analytics backed wealth management firm)
Disclosure: The article has endeavoured to cover key facts associated with long-short alternative investment funds. The content presented is informative in nature, and the intent is education for informed investment decisions and is not a solicitation towards investing specifically in any of the mentioned funds.Disclaimer: The views and investment tips expressed by investment expert on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.