During the month of February and March, india when COVID-19 was heading towards being a Pandemic, all the global stock indices lost nearly 40-60% of their peak index value. The Nifty 50 index in India, from its levels of +12,000 points, came to sub 7000 levels.
During times like these, the investors are desperately on the lookout for funds that could balance out their portfolio, hedge their long positions within the portfolio, and along with generating returns in the falling market. And this is where the investment into ‘Long Short funds’ comes in handy.
Today, we’ll cover Long Short funds in India. However, before analysing more in detail, let us try and understand the basics of what does Long-Short funds mean.
What are Long-Short Funds?
“The art of investment is not to make money in the short span of time, but to ride the turbulent times and eventually when the market settles, the true investors make real money.”
As the name might suggest, a Long Short fund is a fund that has a mix of long and short positions in the market. Long Short funds are a fairly recent phenomenon in the investment market, but more than 35 fund managers have launched these funds in the last seven years and the popularity seems to be on rising. The total AUM in these funds is more than $2 bn (Rs. 15,000 crores) currently.
In this strategy, a fund manager goes long/buys those stocks or assets which have a potential of appreciation in their value and, also initiates short/sell positions in stocks or assets which are overvalued at that time. Through this strategy, the fund is expected to make money, when the market goes up or comes down.
Long Short funds are the largest hedge funds and fall under AIF category-III. These bi-directional funds have multiple ways of being In the Money for the investors. Even though the market might be going down, but the investor’s portfolio could still be going up.
130/30 fund Strategy
Long Short funds are sometimes also called 130/30 funds. This is the investing methodology used by institutional investors in which 130% of the initial capital is used for buying stocks and securities, and this is done by investing 30% in shorting the stocks/securities.
To put it in a more simplified way, the fund manager would invest 100% of the initial fund in buying stocks and short sell 30% of the security. The money received from shorting the security will again be reinvested in buying stocks/securities. The 130/30 fund strategy works efficiently in limiting the drawdown while investing.
What are AIF category-III funds?
AIF is an acronym for Alternative Investment Fund. It comprises pooled investment funds that invest in private equity, venture capital, hedge funds, etc. In other words, AIF is a different form of investment than traditional investment avenues like stocks, debt securities, etc.
Under AIF category-III, the main aim is to earn short term gains by employing complex trading strategies. These are hedge funds employing diverse and complex trading strategies. And they are currently allowed to leverage the capital to an extent of 200% of the total fund size.
Under the AIF category-III funds, the long-short funds are divided into equity and debt-risk funds. The minimum ticket size to invest in this category is Rs. 1 crore. This makes it accessible to a handful, mainly HNI’s.
Advantages of Long-Short funds
Here are a few of the best advantages of Long Short funds in India:
- Diversified Investment: HNI’s looking for diversification in their portfolio have a great opportunity to park some of their money in Long Short funds. It provides stability to the portfolio and downturn in the market or economy is hedged.
- Excess Returns: Because Long-Short funds don’t just rely on the market going up, it provides an opportunity to make returns from both falling and rising markets. Volatility is a friend of investors who is looking to generate higher returns. It, of course, does come at a higher risk on the portfolio.
- Short Selling permitted: Unlike in any other form of Mutual fund, short selling is not permitted. But in the case of a Long-Short fund, short selling is permitted and which in turn can be used as leverage to enter a more fresh long position in the market.
Disadvantages associated with Long Short funds
Every coin has two sides. Now, let us also look into a few of the disadvantages of Long Short funds in India:
- High Expense ratio: In general, the expense ratio in the case of regular Mutual funds hovers around the 0.60% levels, but in the case of a Long short fund, the expense ratio goes up to 2% levels. This ultimately impacts the final returns generated by investors.
- Low return in Range bound market: A long position or short position is entered in the market with a directional view. Because this fund has both long and short positions in the market (in Long Short fund), range-bound or choppy market tend to give very low to minimal returns to investors.
- Stock selection risk: Although the long-short fund has both buy and sell positions in the market, but picking the right stock to buy or sell is at the discretion of the fund manager. And selecting the right stock could still be a risky affair.
- Risky Ventures: As Long-short funds are allowed to trade in the derivatives market, it makes it a little difficult to regulate. Hedge mutual funds are not allowed to be registered with SEBI, so in a way, the fund and its investors are on their own.