And during the period when the S&P 500 inched its way to an all-time high on February 19, many long/short managers were losing money on their short bets because it’s hard to make money shorting stocks during a relentless bull market.

Alitovski notes that investors should consider the longer-term results before deciding whether this strategy is for them. The long/short equity category’s annualized 10-year return of 4.1% (through April 30) was the best among Morningstar’s seven liquid alts categories, but it significantly trailed the 11.7% average 10-year return on the S&P 500.

Then again, long/short equity isn’t designed to shoot out the lights during bull markets. Employing strategies designed to lower the correlation to the overall equity market will inherently limit the upside in bull markets (while hopefully limiting the downside in bear markets).

“I don’t think they [long/short equity managers] can add outperformance over equity markets,” Alitovski says. “But when you take their beta exposure into account, I think they can add alpha on a risk/reward perspective.”

One way to look at it, he says, is if a long/short equity fund has a 0.5 beta and the market returned 10% over an annualized five-year period, and if this fund returned less than 5%, that means it underperformed expectations.

Market Conditions
Alitovski says long/short managers tend to do better in slightly volatile market environments. “You don’t want a super-low volatile environment because that means prices aren’t moving much, making it hard for long/short managers to add value,” he explains. “But you don’t want super-high volatility because that means prices are moving in the same direction.”

Sal Bruno, chief investment officer at IndexIQ, believes long/short equity should be seen as a strategic holding in a portfolio’s alts sleeve. “I think it’s more strategic because you want the managers themselves to be tactical within your long/short.”

The IQ Hedge Long/Short Tracker ETF (QLS) tracks an index that seeks to replicate the risk/reward profile of long/short hedge funds. Rather than tracking individual managers, the index comprises ETFs that go long or short on particular sectors or investing styles.

“For example, are these managers tilted more toward growth or value, because growth has been a winning trade,” Bruno says.

The QLS fund was down nearly 12% in this year’s first quarter while the HFRI Equity Hedge Index dropped 13%. But it had 2.1% five-year average annual returns while the HFRI index gained only 1.3%.