By Amar Ranu
We are currently living in a market condition where both equity and debt markets have been volatile and have been creating havoc on investors’ portfolios. Inflation has become a big headache for central banks across the globe than managing growth which led to quick and successive interest rate hikes. This tumbled both the debt and equity market with heightened volatility.
Long-Short Funds, a Category III AIF, in existence for more than a decade have been the volatility soother and aim to generate absolute returns irrespective of market movements with lower volatility than the overall stock market and have a low correlation to conventional financial assets in all market scenarios.
Unlike regular equity markets where the standard deviation tops in higher of teens (18-20%), long-short funds clocks in low single digits (ranging from 4-8%).
How does it work?
Here the fund manager takes both long and short positions across market conditions either individual stocks or sectors or indices. Unlike Mutual Funds or PMS where the leverage is not allowed, here the SEBI has allowed leverage up to 2x of fund i.e. the fund can leverage up to 200% of their AUM. Saying that most of fund managers keep it conservative and manages gross positions (long plus short) below 200% and the net positions either become very low or in some cases negative (long minus short). It involves lots of models like pair, momentum, mean-reversion or sector-neutral. The long-short fund manager adjusts the net exposure following their investment outlook – bullish, bearish or neutral. While being net long reflects a bullish strategy, being net short reflects a bearish one.
How big it has grown and who can invest?
Since its inception in 2012-13, long-short AIFs have gone long way in terms of acceptability which is quite reflective from roughly INR 12-15k crs managed across many investment managers and the popularity seems to be on rising further. Some of the biggest players which operate long-short funds are Avendus Capital, ICICI Pru AMC, ITI AMC, True Beacon etc.
Since it is structured as an AIF, the minimum investment amount is INR 1 cr. Most of HNIs, Corporate, Trusts etc invest in this.
Are all long-short funds the same?
Unlike market perception, long-short funds’ strategies vary across AMCs. Few are positioned as Fixed Income (+) long-short funds where they aim to generate Fixed Income (+) return on post-expense and post-tax basis, others are Equity (+ / -) Plus or Minus long-short funds which aim to beat the underlying equity benchmark like Nifty 50. While the former has lower standard deviation of 4-8%, the latter comes with a volatility of 15-20% unlike Nifty’s Std Deviation of 20%+.
Since it is market neutral or absolute return fund, it provides an opportunity to make returns from both rising and falling markets. It lowers the risk of capital losses and opens-up upside potential to make an equity equivalent returns. Hence, it acts as a great diversifier in the overall portfolio.
Since the strategy involves complex market models including leverage, the net return (post of all expenses) is fully taxable (at maximum marginal rate) at fund level.
What one should expect in terms of market returns?
Depending upon the type of long-short funds whether they are managed as fixed income (+) or equity (+/-), the return varies over a long band. An investor in a fixed income (+) long-short fund should expect 13-16% on a gross basis which on post expense and post-tax basis would generate 6.5-7.5% with standard deviation of 4-7%. Similarly, an equity (+/-)s long-short fund should deliver north of Nifty 50 returns with a standard deviation lower than that of Nifty 50. The returns may vary depending upon what share class one chooses.
The asymmetric return profile makes the long-short fund one of the best investment platforms to compound wealth for the long term with lower volatility and better risk management. It helps in reducing volatility in the overall portfolio with similar return expectations.
(Amar Ranu is the Head – Investment Products & Advisory, Anand Rathi Share & Stock Brokers. Views expressed are the author’s own. Please consult your financial advisor before investing)