By Nick Evans
There is still a quarter of this exceptionally turbulent and
uncertain year left to go, and much could yet change for better
or worse, but 2011 has clearly not been a vintage year for
long/short equity – most of all in Europe.
For several individual funds, it has been borderline
disastrous – with some down as much as, or even more
than, the markets themselves after a thoroughly rotten third
For a notable few, it has provided the chance to shine in
the toughest of circumstances – and those who have
prospered through the chaotic markets of July, August and
September should be amply rewarded by investor inflows.
But for the vast majority, it has been a hard and
unrewarding slog – with stock-picking, both long and
short, proving almost impossible at a time when equity markets
are in the grip of whipsawing macro sentiment and when
fundamental valuations appear to count for little.
Overall, the correlation with equity markets is ticking up
– which is the last thing that investors want to see.
And the universe of funds that can truly point to consistent
success at uncorrelated returns, capital preservation and alpha
generation is shrinking.
So is long/short equity somehow 'broken’? Could
it be the case – in such a febrile risk-on/risk-off
market where conviction is dangerous, where leverage is
reduced, where short-selling bans curb flexibility, where the
macro mood is prone to sudden and savage swings, where
investors want the upside but not the downside, and where the
penalty for being wrong is far higher than the reward for being
right – that long/short equity just
That would be an overly generalised and simplistic
conclusion. Overall, the EuroHedge long/short European equity
index is down by some 5% this year – against markets
that have fallen by some 12%, and which were down by some 20%
in the third quarter alone.
That does represent a creditable degree of downside risk
protection and relative outperformance – underlining
that managers are, in aggregate, doing their job for investors
whose long-only portfolios are doing far worse.
Of course, hedge funds were not supposed to be about
relative returns. Indeed it was a desire to get away from a
long-only culture where losing less than the market was deemed
to be acceptable that drove so many managers into long/short
investing in the first place.
But human nature being what it is, relativity is never far
away – and it is that relative outperformance, which
so many managers scoffed at in earlier and perhaps easier
times, that may now prove to be their saviour and chief selling
Over a longer timeframe, the relative outperformance
argument stands up even more powerfully – and there
cannot be many investors left who are not painfully aware that
if they had invested substantially more of their money in
long/short equity rather than long-only over the past 10 years,
they would have substantially more of it now than they do.
For institutional investors charged with funding long-term
liabilities, that is a very compelling argument – and
one that can no longer be ignored. But it holds true for every
kind of investor. By dampening volatility, mitigating tail risk
and avoiding the large capital losses that kill compound
returns, long/short equity does truly add value.
So, far from abandoning long/short equity, many investors
are now questioning if now is the time to put all of their
equity portfolios into long/short and to end the nonsensical
split between long-only equity and hedge funds (as if hedge
funds were somehow a separate asset class, rather than a style
of managing money).
Of course there are investors in funds down 20% or more this
year who are questioning the value proposition of long/short
equity. But distinctions will be drawn between those that can
show good performance over time and can clearly explain their
drawdowns – who will probably be given another chance
– and those that can’t, who almost
There will doubtless be some heavy recycling of assets
between funds that have coped well with this torrid time and
those that haven’t. For long/short equity as a
whole, market correlations cannot afford to rise too much
further without serious questions being asked over the fees
compared with the long-only world. And it is questionable
whether 2 and 20 is really the price that investors are
prepared to pay for long/short equity these days anyway.
But long/short equity is not dead. On the contrary, what
appears to be a very bad and worrying year may actually turn
out to be the start of a major change in investor attitudes in
favour of, rather than against, the long/short model –
but the price may need to change.