Your regional office
Select your investor profile:
This content is only for the selected type of investor.
Institutional investor?
Demystifying long/short equity strategies
When markets encounter turbulence, it is tempting to eliminate stocks from your portfolio. But, for many investors, allocating capital to long/short equities might be a better option.
Written by
Steve Huguenin-Virchaux, Head of TR Equities Product Specialists
Global equity markets have suffered dramatic falls over the past two months as the spread of the coronavirus continues to cause significant social and economic upheaval. With a world recession looming, many investors could be forgiven for wanting to further cut back on stocks. Yet doing so at this juncture carries risks.
A rebound, when it comes, would be missed. And, as history shows, once market recoveries take root, they are usually very powerful. Most investors understand this, but remain fearful of a deeper correction. Hourly updates on the spread and effects of the coronavirus naturally chip away at confidence. But there is a way of resolving this dilemma: allocating some capital to long/short (L/S) equity strategies. Such portfolios are designed to offer investors a more flexible approach to equity investing. They help investors retain exposure to equities - a positive in the event of a recovery - but aim to shield them from the worst effects of any further market falls.
More specifically, they are designed to capture the market’s ‘upside’ when equities are rising but preserve capital whenever the investment climate turns sour.
Such strategies can do this because they use techniques that are unavailable to long-only investment funds. As their name suggests, L/S portfolios take both long and short positions in securities. In other words, they buy shares in companies with the strongest growth prospects and express negative views on firms they believe will suffer a long-term decline in profitability. Their returns stem partly from a controlled, actively managed exposure to the market, and partly from the security selection skills of the investment manager.
The ability of an L/S strategy to mitigate volatility and limit the scale of losses is particularly important to investors as can reduce the long-term impact of market declines. Indeed the power of compounded returns, a critical concept in the wealth creation process, means that, for example, a 25 percent decline in the value of investments requires a subsequent 33 percent rally to fully recover lost ground.
Because of these attributes, L/S equity strategies are able to perform a specific function within a diversified portfolio: they can serve as a substitute for some or all of the equity allocation with the potential to improve its risk-return profile.
In recent years, the ability to dampen the volatility of equity investments was not in particularly high demand – equities were surging while the market conditions remained unusually calm.
Low interest rates and quantitative easing were keeping a lid on equity market volatility, creating the conditions for individual stocks to move up more or less in lockstep with one another.
But market dynamics have been changing rapidly in recent months. And the economic effects of the coronavirus could last many years.
As businesses' profit margins come under intense pressure, firms won't be affected in the same way. Companies with poor management and flawed business models will find it harder to service their debts and, therefore, generate attractive returns for shareholders. Those with stronger balance sheets and earnings power, by contrast, will thrive.
When market leaders pull further away from laggards, investment strategies whose returns depend almost entirely on the stock-picking skills of portfolio managers can deliver strong returns over the long run.
Our research also shows that during the two major bear markets of the past 20 years – January 1999 to September 2002 and October 2007 to February 2009 – long/short equity funds offered investors a far greater degree of capital protection.
Overall, then, we believe that current market conditions require a more agile approach to equity investing. Including long/short equities as part of a broader portfolio allocation to stock markets can offer a degree of capital protection but also the possibility to reap rewards once markets recover. That's likely to become even more important in a post-coronavirus world.
Read more
Demystifying alternative investments
Andrew Cole, Head of Multi Asset London
March 2018
Important legal information
This marketing document is issued by Pictet Asset Management. It is neither directed to, nor intended for distribution or use by any person or entity who is a citizen or resident of, or domiciled or located in, any locality, state, country or jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation. Only the latest version of the fund’s prospectus, the KIID (Key Investor Information Document), regulations, annual and semi-annual reports may be relied upon as the basis for investment decisions. These documents are available on assetmanagement.pictet.
This document is used for informational purposes only and does not constitute, on Pictet Asset Management part, an offer to buy or sell solicitation or investment advice. It has been established on the basis of data, projections, forecasts, anticipations and hypothesis which are subjective. Its analysis and conclusions are the expression of an opinion, based on available data at a specific date. The effective evolution of the economic variables and values of the financial markets could be significantly different from the indications communicated in this document.
Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to change without notice. Pictet Asset Management has not taken any steps to ensure that the securities referred to in this document are suitable for any particular investor and this document is not to be relied upon in substitution for the exercise of independent judgment. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Before making any investment decision, investors are recommended to ascertain if this investment is suitable for them in light of their financial knowledge and experience, investment goals and financial situation, or to obtain specific advice from an industry professional.
The value and income of any of the securities or financial instruments mentioned in this document may fall as well as rise and, as a consequence, investors may receive back less than originally invested. Risk factors are listed in the fund’s prospectus and are not intended to be reproduced in full in this document.
Past performance is not a guarantee or a reliable indicator of future performance. Performance data does not include the commissions and fees charged at the time of subscribing for or redeeming shares. This marketing material is not intended to be a substitute for the fund’s full documentation or for any information which investors should obtain from their financial intermediaries acting in relation to their investment in the fund or funds mentioned in this document.
EU countries: the relevant entity is Pictet Asset Management (Europe) S.A., 15, avenue J. F. Kennedy, L-1855 Luxembourg
Switzerland: the relevant entity is Pictet Asset Management SA , 60 Route des Acacias – 1211 Geneva 73
Hong Kong: this material has not been reviewed by the Securities and Futures Commission or any other regulatory authority. The issuer of this material is Pictet Asset Management (Hong Kong) Limited.
Singapore: this material is issued by Pictet Asset Management (Singapore) Pte Ltd. This material is intended only for institutional and accredited investors and it has not been reviewed by the Monetary Authority of Singapore.
For Australian investors, Pictet Asset Management Limited (ARBN 121 228 957) is exempt from the requirement to hold an Australian financial services license, under the Corporations Act 2001.
For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.
For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.
Pictet Asset Management Inc. (Pictet AM Inc) is responsible for effecting solicitation in North America to promote the portfolio management services of Pictet Asset Management Limited (Pictet AM Ltd) and Pictet Asset Management SA (Pictet AM SA).
In Canada Pictet AM Inc. is registered as Portfolio Manager authorised to conduct marketing activities on behalf of Pictet AM Ltd and Pictet AM SA. In the USA, Pictet AM Inc. is registered as an SEC Investment Adviser and its activities are conducted in full compliance with the SEC rules applicable to the marketing of affiliate entities as prescribed in the Adviser Act of 1940 ref. 17CFR275.206(4)-3.