Alternative investment strategies are one answer; so-called non-correlated asset classes that rise and fall independently of stocks and bonds can mitigate losses and enhance returns in increasingly volatile investing environments driven by hyper-connected global markets.
Long/short equity, one particular hedged growth investment strategy, can limit volatility within the portfolio, stabilize the sequence-of-returns and narrow the possible outcomes to help investors and their advisors better plan.
Indeed, long/short equity strategies lost about 20 percent, on average, during the aforementioned financial crisis. Yes, it was painful, but nowhere near the losses of 50 percent or more experienced by many equity indexes.
Traditionally reserved for the “satellite” portion of the portfolio, its ability to participate in equity markets while managing downside risk is fueling an argument for long/short equity as a core position. It is, after all, a strategy that invests in equities, and more often than not, does so with net exposure to equites well below 100 percent. As such, it ends up looking quite similar to a more diversified combination of equities and cash or bonds.
Long/short equity portfolio managers and analysts also expend tremendous effort in identifying investment opportunities with higher expected risk-adjusted returns than the overall market. Through these efforts, they likewise come across securities with lower expected risk-adjusted return profiles. Long-only equity portfolio managers utilize such information primarily to avoid stocks with poor outlooks. Long/short managers, on the other hand, are afforded greater flexibility to fully express their views on all securities that they research, improving investment efficiency.
Hedged growth strategies such as long/short equity potentially turns the math of a big loss into an equation for a big gain, by lessening the amount of risk, and the time-horizon needed to recover, helping to ensure the individual doesn’t run out of money before they run out of life.
Clifford Stanton, CFA, is co-chief investment officer of 361 Capital.