Investing

Australian long-short funds have largely outperformed the sharemarket during a dismal year for equities returns in 2011, but the news is cold comfort for investors who picked the average fund manager and suffered losses of over 8 per cent.

Interest in long-short funds – many of which employ strategies designed to provide positive returns regardless of market conditions – is rising among retail investors.

Uncertain certainty

Investors are contemplating parking more of their money in these funds, which strive to offer positive returns by investing in strongly performing stocks and shorting others that are expected to perform poorly, to garner more certainty in returns.

But many of these strategies are arguably riskier than traditional long-only funds. Pick the wrong player and an investor could end up with staggering losses thanks to bad stock calls.

Research from Mercer shows the average Australian shares long-short manager posted a median 8.8 per cent loss for the year to December, against the market’s 11 per cent fall.

Only two funds out of the 16 rated by Mercer yielded positive returns (the top performing BlackRock Equitised Long Short fund returned 6.5 per cent during 2011, while Regal Australian Long Short Equity Fund secured a 3.1 per cent return).

Funds at the bottom performed worse than the stockmarket (with the Tribeca Alpha Plus Fund, for example, losing 15.8 per cent).

Thick and thin

But investors who had stuck with some of these strategies would have see their investments pay off.

Over five years, long-short managers’ returns averaged 2.5 per cent compared with the 1 per cent loss sustained by the average long-only manager for the same period.

Mercer principal David Carruthers said there were multiple types of long-short strategies (such as market-neutral and 130/30 funds), all with different characteristics and investment ethos.

Financial adviser Brenton Tong of Financial Spectrum said there was a strong role for long-short strategies amid turbulent markets, and investors were increasingly aware of their benefits.

“I don’t believe they are a replacement for long-only funds, but long-short funds operate independent to market movements, so what you have to do is find a good manager with a good investment history,” Mr Tong said.

“It’s about how in the bad times they made returns, and in the good times they also make returns.”

Sophisticated investors

Clients who typically hold long-short funds in their portfolios are younger, sophisticated and market-savvy individuals, or more established investors.

Mr Tong said he would recommend up to 15 per cent of clients’ local shares be allocated to long-short strategies.

‘Grabbing at straws’

But other advisers are more wary and prefer to steer clients away from these offerings.

Michelle Kelly of Chrysalis Financial said expensive long-short funds were not worth the potential damage they could wreak on investors’ share portfolios if managers picked the wrong stocks.

Managers often charge a base fee to manage money, plus a cut, say 30 per cent, of any outperformance achieved on the investment strategy.

“It causes a massive layer of fees. People are grabbing at straws,” Ms Kelly said, arguing that derivatives such as call and put options were better alternatives to hedge risks.

This sentiment was echoed by fellow adviser Mark Draper of GEM Capital Financial Advice, who also abstains from using long-short funds in portfolios.

“I prefer to use options for downside [risk mitigation] rather than through shorts,” he said.

Stress tests

Despite some advisers’ concerns, fund managers are reporting increasing inquiry rates and fund flows into long-short strategies.

BlackRock’s head of scientific investments, Michael McCorry, said much of a fund’s success was due to disciplined research.

“We do stress tests, we do everything as vigorously as possible to identify which factors are going to work,” Mr McCorry said. “We exploit mispricings in the market, but do this in an incremental risk-controlled manner.” The end result could be a rewarding return for investors, particularly in flat or falling sharemarkets, he said.

Andrew West, portfolio manager at Regal Funds Management, said his firm’s fund made money by exploiting Australia’s two-speed economy, by shorting weak-performing sectors such as discretionary retail and Australian manufacturing.

Mr West said investors were increasingly on the hunt for alternative funds in which to park their money after years of losses. “We see increased enquiries from investors, definitely. Investors are seeing the outperformance of our strategies,” he said.

A big universe

Australian chief executive of Invesco, Mick O’Brien, warned that long-short funds might not always produce positive returns.

“Picking winners isn’t easy,” he said. “But if you have the opportunity to pick losers you’ve doubled your universe of options to invest in.”