Long-short funds, of course, have the power not only to bet for stocks, but bet against them. But the subject quickly becomes tricky, say sophisticated long-short fans, because shorting involves considerable risks. It’s not as simple as buying companies you like and betting against those you don’t, says Cleo Chang, the CIO of Wilshire Funds Management in Santa Monica, which looks for long-short funds to invest for clients like broker-dealers, insurance companies and RIAs.

She says novel vehicles like 130/30 funds, (so named because they hold 30% short and use proceeds from the short sales to buy 130% long), were problematic because they did not corral risk so much as amplify stock sentiments. They were a hot item circa 2008, but they were mauled by the bear market. Companies such as Fidelity, Munder, ING and Legg Mason either wiped them off the books or merged them into other funds.

“One of the things that was learned by retail investors and institutional investors for that matter in the 130/30 era,” says Chang, “was that just because a manager knows how to [go] long a stock and they rank their stock universe from best to worst, that doesn’t necessarily [mean] they know how to run a long-short portfolio.

“What was overlooked and underappreciated is that if you have a short position that’s not a covered short, your potential loss on that position is unlimited. Shorting a certain stock relative to an index is not the same as not holding that stock.”

If a manager doesn’t have the expertise, Chang says, he or she won’t properly quantify the risk exposure, and if things go wrong, won’t know how to react. A manager might have trouble getting out of the positions when liquidity dries up, for instance, since funds depend on borrowing from custodians. “You want to know how much of that particular stock is being shorted because there could be a squeeze on supply.”