The Long And Short

’40 Act
Financial advisors are increasingly enticed by alternative investment strategies available in the comfort of regulated 1940 Act funds. Equity long-short is a hedge fund strategy that may translate best into these vehicles. Not only can these funds short individual shares that are sufficiently liquid, but there’s an abundance of ETFs that offer all sorts of inverse exposure.

From a fiduciary, due diligence and liquidity perspective, ’40 Act funds appear to be a lot easier to deal with than hedge funds. Regulatory oversight suggests verification of these funds’ legitimacy. Advisors, nonetheless, still need to do their homework.

Mainstay Marketfield (MFLDX) is the largest such player in the space, running $19 billion. It has generated nearly 8.5% annualized returns since it started up in July 2007, with annualized volatility that has run around 9% over the past five years.

“Our fund takes a different, top-down approach to investing than most hedged equity funds, which tend to invest bottom-up,” explains manager Michael Aronstein, who has been running the fund since inception. The manager looks for broader macro themes to guide his long and short positions.

Between 2012 and early 2014, he played the European equity recovery, with a special emphasis on Irish stocks. “I was impressed by the government’s commitment of keeping corporate tax rates low despite budgetary hardship,” says Aronstein. As a result, the country appears to be emerging from the crisis economically stronger than many other European markets.

Aronstein does significantly alter his exposure; he ran a net long as low as 30% in 2011 to a net long peak of 75% in 2009. But typically his book is net long around 60%. And while 70% of assets are in equity, about a third could be in macro plays like commodities, currencies, interest rates and stock indices.

Hedge funds require more work to vet, their regulatory oversight is less robust, they are less liquid than ’40 Act funds, and their operations involve more moving parts that can go wrong. Minimum investments are much higher, as are their fees.

But these managers tend to be a different breed, more aggressive, willing to explore more obscure spaces. For sure one can get burned. But the right long/short hedge fund managers can offer superior performance and risk management across most markets.