Views From The Experts


Brad Balter
CEO, Managing Partner
Balter Liquid Alternatives, LLC






Size Does Matter: Rebooting Your Thinking On Long/Short Equity


Long/short equity has long played a central role in diversified hedge fund portfolios. The appeal of a long/ short equity fund is the prospect of outperforming the market over an economic cycle, with lower volatility and drawdown. In our view, it should also provide a complementary and differentiated return stream to the broad market. Managers stand the best chance of accomplishing this by focusing on less efficient areas of the market, specifically small-cap companies. Most long/short equity managers do not focus on small-caps for a variety of reasons but, most notably, the asset class doesn’t allow them to grow their fund to a “sufficient” scale. Alpha isn’t easy to generate and it is harder to come by with significant assets under management. More recently, many allocators have grown frustrated with the performance of their long/short equity allocation as it has failed to meet their expectations. The two chief culprits for this are market cap focus and crowding in common names by other hedge funds. Both issues can be remedied by focusing on less efficient areas of the market.


There are certain sub-strategies in our view that are ideal for long/ short equity investing, where there are both winners and losers. In our view, small caps are a better alpha driver than large caps. Small caps are a highly inefficient space because a majority of the dedicated research is focused on the large-cap part of the spectrum. Small-cap inefficiencies can be even greater in other developed equity markets, such as Europe and Japan. As alpha has become more difficult to generate, investors need to look in less efficient areas in order to find it. We believe it is worthwhile to select long/short equity managers that primarily focus their efforts looking under the smallest rocks, as chances are few will be looking there. Simply put, size matters.


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