Outperformance of long/short funds coincide with drawdowns

Oksana Patron

28 November 2022

The Zenith Investments Partners’ analysis looked at volatility reduction of long/short funds in market downturns and found that the outperformance of long/short funds generally coincided with drawdowns in equity markets.

Zenith believed that by protecting investors against significant losses, long/short investors could generate long-term outperformance.

“We found that over the long term, long/short managers captured just 34% of market declines. However, they were able to participate in 47% of the market upswings,” the analysis said.

It also found that during periods of relatively high interest rates, active long/short managers delivered excess returns. However, they tended to lag in low-rate environments.

“Periods of low interest rates have an expansionary impact on risky-asset valuations, which provides a headwind for long/short funds with lower net market exposure,” Zenith said in its report.

Given the ability of long/short funds to adjust net market exposures and risk-taking levels depending on the prevailing market environment, the volatility (as measured by Standard Deviation) of these strategies was expected to be significantly lower than broader equity markets.

With global equities taking a downturn at the beginning of 2022, the expectation would be for Zenith’s rated global long/short funds to offer downside protection.

“Over this period, the median global long/short fund declined 6.6%, which compares favourably to the market’s decline of 15.8%. This represents a downside capture of 41%, which is comparable to the long-term figures outlined earlier.”