The long and short of long/short equity performance in this year’s tumultuous first quarter is that some funds came up long but many funds fell short.

Long/short equity is a hedge fund strategy consisting of buying undervalued securities expected to rise and shorting overvalued securities expected to decline. This strategy can also employ leverage and derivatives to lessen market volatility. The goal is to produce positive returns from both rising and falling prices while maintaining a lower correlation to the overall market. In theory, this should generate competitive risk-adjusted returns while minimizing or hedging against losses in market downturns. The plethora of long/short mutual funds and exchange-traded funds has made this approach accessible to retail investors.

Many investors hoped the long/short equity fund universe would come through in the clutch when stocks crashed in March. By and large, it didn’t.

“Looking at first-quarter results, you can quickly make the assumption that they underperformed and disappointed,” says Erol Alitovski, a liquid alternatives analyst at Morningstar.

And things didn’t improve much in April. Data from Morningstar Direct shows the long/short equity category was down 8.2% this year as of April 30, making it the worst-performing group among Morningstar’s seven liquid alternative categories. The S&P 500 lost 9.3% during that period. So while long/short equity barely outperformed the broader equity market on a relative basis, the amount was so small it doesn’t even qualify as a moral victory.

But the long/short equity strategy has its merits, and this article will look at why this category recently scuffled and what investors should consider if they want to invest in this space.

First, the bad news. There has been a huge performance dispersion among long/short equity mutual funds. According to Morningstar, the top performer gained nearly 40% this year through April, while the worst performer lost more than 61%. In between, there were significantly more losers than winners—only 13 funds were in positive territory, and roughly 45 funds registered double-digit losses.

And long/short equity mutual funds as a group were the worst-performing category during the one-year period through April, as its negative 5.1% return trailed the aggregate average return for all liquid alts categories by 200 basis points.

Alitovski points to a couple of reasons for this. First, the long/short category’s emphasis on undervalued stocks put it on the wrong side of the market as growth and momentum stocks continued to significantly outperform.

“The combination of technical and fundamental factors contributed to value’s underperformance, and a large subset of long/short managers have a sensitivity to the value factor,” Alitovski explains. He adds that many funds suffered as their long bets went south in March.

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