Long-short strategies use hedging techniques that long-only strategies do not accommodate. This provides opportunities to mitigate downside, reduce portfolio losses, and allow for a potentially quicker recovery after a market downturn.
What Is Long/Short Investment?
A long investment strategy involves buying stocks portfolio managers believe will outperform, with the goal of profiting from increases in their prices.
In a short strategy, managers look for stocks they believe will underperform. Profits are realized when these stocks decrease in price.
A long/short strategy buys undervalued stocks managers believe will rise in price, while simultaneously selling short potentially overvalued stocks. This combination of strategies offers the potential for achieving higher risk-adjusted returns in the long term.
Why Is a Long/Short Strategy Beneficial in the Long Term?
There are two significant long-term benefits to a long/short strategy.
One is that a reduction in portfolio losses over market cycles can provide a meaningful boost to long-term results. A mathematical illustration: Unhedged Portfolio A declines 50%, so it will need to grow 100% to regain its original value before the decline; Hedged Portfolio B declines only 25%, so it will need to appreciate 33% to recover its original value before the decline.
The other benefit is related to investor psychology.
Experiencing a sharp selloff can be stressful for even the most experienced investor and may cause emotion-based decision-making. Investors may panic and sell during a decline and then miss the beginning of the market recovery, delaying their own recovery and potentially reducing their long-term returns.
A long/short strategy that mitigates losses may encourage investors to stay fully invested through a downturn and be in a good position to participate in the subsequent rally.
What Is a Quality-Driven Long-Short Strategy?
Long/short equity strategies use a variety of differentiators in choosing their stocks, including sector (technology, transportation, etc.), market geography (advanced economies, emerging markets, domestic, etc.), market capitalization (large cap, mid cap, small cap), and investment philosophy (value or growth). However, whatever their differentiator, most tend to focus primarily on valuation.
The KAR Long/Short Equity strategy is different. We use a disciplined quality-driven process to purchase long positions in high-quality companies and sell short positions in low-quality companies, generally with a net long bias.
We buy high-quality businesses with:
- Durable competitive advantages
- Strong fundamentals
- Reasonable valuations
We sell low-quality businesses with:
- Mediocre or poor financial performance
- Flawed business models
- High financial leverage/balance sheet risk
For additional information about long/short strategy benefits, read our detailed White Paper and consult with a Kayne Anderson Rudnick representative today.
This report is based on the assumptions and analysis made and believed to be reasonable by Kayne Anderson Rudnick (“KAR”). However, no assurance can be given that KAR’s opinions or expectations will be correct. This report is intended for informational purposes only and should not be considered a recommendation or solicitation to purchase securities. Past performance is no guarantee of future results.