A Closer Look At Long/Short Strategies

rogernusbaum

I've written quite a few posts mentioning long/short as a potential tool for adding defense to a portfolio as a means of trying to manage or dampen volatility. Usually I will caveat it along the lines of you needing to understand what a particular long short fund is actually trying to achieve and using past performance as a means of setting expectations for future results. Anything about past returns is a watchout situation but that doesn't mean you should never do it. The context in this instance is expectations for volatility and correlation not an alpha seeking stock picker.

Long time readers know I've maintained a position for clients and personally in BTAL which goes long low beta (beta in simplistic terms is a measure of volatility) and short high beta. It is intended to not look like the stock market. No matter what you think about BTAL it is clear that it tends to not look like the stock market more often than not. That makes it a good diversifier (in my opinion of course) and why I have it in portfolios.

The purple line in the chart is the S&P 500. SPYG tracks growth stocks in the S&P 500 and if you didn't know, we've been in a multi-year period where growth has trounced value which means that proxies for growth stocks should be outperforming the broader index which has been the case. RWGV is the Direxion Russell 1000 Growth Over Value ETF which has 150% long growth stocks while being 50% short value stocks, so it too is a long/short fund. Being long growth and short value in this environment it makes sense that RWGV would be way ahead of both the broad index and the narrower growth index. RWGV's chart resembles the broad market, it's just outperformed by a lot.

RWGV may or may not be a great fund but what it isn't is a reliable tool for defensive action, it should not be expected to dampen volatility when added to a portfolio. Interestingly it fared a little better than the S&P 500 during the worst of the Covid crash but was still down a lot compared to BTAL which was up during the Covid crash. It's not that BTAL is a better fund, it does something different, it sets a different expectation and for my money delivers on that expectation.

If growth outperforms value forever (intentionally hyberbolic example) then RWGV should outperform forever. At some point value will outperform though, throwing in the towel on when that might happen, and when it does it would make sense that RWGV will lag because that is the expectation set by long growth/short value.

When it comes to viewing a fund as good or bad I am just as interested in whether it does what it's supposed to do or at least what I think it is supposed to do. I always say of gold that it has the historical tendency to look different than stocks more often than not so I keep a little in client portfolios. That is what I am looking for from long short and from all defensive tools. I don't think this gets talked about enough. Gold is a common enough holding in diversified portfolios but I don't think other defensive tools are anywhere near as common. I think they make navigating market cycles and volatility much easier to do but you should draw your own conclusion.