UKOct 24 2019

Long/short strategies may work for some investors

Supported by
JP Morgan
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Supported by
JP Morgan
Long/short strategies may work for some investors

Fuelled by the ongoing Brexit saga, the trade war between China and the US and the global slowdown, markets are moving up and down faster than a yo-yo.

In times of such extreme volatility, however, is there a case for advisers and their clients to consider using shorting strategies within an investment portfolio?

“The more progressive advice firms, which place a real focus on wealth management, are certainly becoming more open to strategies that can provide added value to clients,” highlights Victoria Hicks, director at City & Capital Acquisitions.

“However, it is important for advisers to continue to adapt and research different investment strategies in order to ensure those recommended are appropriate for their customers’ objectives, risk profile and capacity for loss.”

Traditionally, long-short strategies were reserved for hedge funds and for a long time were considered inaccessible to retail investors.

However, boosted by investor demand for market-suitable products, the number of traditional asset and fund managers adopting such strategies has increased significantly.

Shorting

MontLake chief executive, Cyril Delamare, explains: “Alternative investments have made their way into European regulated fund structures, namely UCITS.

When a fund includes short strategy, this does pose the potential for significant losses Victoria Hicks, City and Capital Acquisitions

“You have a number of UCITS funds which have alternative hedge fund strategies that provide short exposure to stocks and bonds in their portfolios, so there are a number of offerings that advisers can choose from.

“The reason why they’re choosing to increase their exposure to these types of strategies is that everybody agrees that we are getting towards the top of the market, towards the end of a cycle.

“Alternative strategies tend to perform well in protecting portfolios and work well on the downside when you are at those inflection points, with a potential slowdown of the economy or an increase in potential market volatility.”

With freedom, however, comes responsibility and this is certainly the case when it comes to shorting the market.

The aim of such strategies is to take advantage of profits that can be made by short selling a stock and benefiting from a decline in a company’s share price.

In contrast, a long strategy – or conventional method of investing – would purchase shares that are expected to increase in value over time, at which point a profit can be made.

“When a fund includes short strategy, this does pose the potential for significant losses,” Ms Hicks says.

“It is therefore important to not only assess the client’s investment priorities, but also their risk profile and ability to withstand fluctuations, without impacting upon their standard of living.”

Not all long/short funds are the same

She adds that it is important to not assume that all long/short strategy funds are the same.

“Look at the fund objectives as these can vary dramatically, and ensure they are aligned with your client’s investment objectives.

“The experience of the fund management team can also significantly influence performance goals. As such, it is important to pay particular attention to the fund managers, their credentials, ethos and past performance,” she explains.

JPMorgan Asset Management, however, disagrees that utilising a short strategy has to increase the risk within a portfolio.

Callum Abbot, Portfolio Manager for the JPM UK Equity Plus Fund and JPM UK Equity Core Fund explains: “Investors should be aware of whether a fund is using short positions as part of an absolute return strategy (hedge fund) or to help beat the benchmark (active extension/130:30 funds like JPM UK Equity Plus).

“Shorting can be a bit of a bogey word but advisers should be aware that shorting does not have to increase the risk of a fund.

“For example, the average active UK equity fund manager is long only and on average has a 30 per cent overweight to mid and small-cap funds, which is a big size risk.

“In JPM UK Equity Plus we go long the mid and small-cap stocks we like but offset this position by going short those we do not, which means that we do not have to have a big size bias in the way many of our peers do – we are actually using shorting to control risk.”

Montlake’s Mr Delamare agrees: “Shorting is not necessarily riskier than investing long, however you have to know what shorting activity the portfolio manager will conduct and to what level, as you have funds that are exclusively shorting that can be more volatile than say a market neutral fund, that is trying to protect you from market swings and have lower volatility.”

As with anything related to investing, cost also plays a major part in any adviser/client portfolio decision.

According to Ms Hicks, funds that have the ability to go short as well as long tend to be significantly more expensive than the more common long-hold strategies as a result of trading costs.

However, she adds: “Mifid II has strengthened the requirements on disclosing fees and charges, therefore additional costs should be justified in line with the client’s requirements.”

Exploring different investment avenues and the potential benefits and risks associated with them can be daunting for advisers and their clients alike. There is no denying that alternative investments are becoming more prevalent in client portfolios as both they, and the markets, become more sophisticated.

Making the right call ultimately comes down to research and due diligence.

“The key thing to understand is who will be managing the fund and running the strategy. The person or team needs to have the relevant experience and proven track-record whether that be in UCITS or other vehicles such as offshore or managed accounts,” concludes Mr Delaware.

“It’s important to work with experts that have worked within the alternative industry for a long time.”