Long/short fund is the type of mutual funds or hedge fund. It makes the typical long and short positions in investments from a particular market segment.
With this fund, investors are also able to use some alternative investing techniques, like leverage, derivatives and short positions. Those techniques are usually used if they want to buy relatively undervalued securities or sell overvalued securities.
People usually also call this fund as 130/30 funds or enhanced funds.
Defining Long/Short Fund
Generally, long/short funds aim to enhance the possible return gained from investing in a specific market segment. This strategy involves actively taking both long and short positions in the securities.
This strategy uses various active management techniques to decide the portfolio holdings. Investors using this strategy may also use leverage, derivatives, and short position in order to increase the fund’s potential return and the risk of the funds.
It has some similarities to hedge funds. They, both, offer investment strategies that have bigger risks and greater return potential, at the same time.
Yet, most of the long/short funds involve higher liquidity securities, no lock-in period, and lower fees than hedge funds. But, if we compare this fund to the most mutual funds, it still has less liquidity and higher fees.
Besides, it also requires higher minimum investment capital than most of the mutual funds. It is closely regulated than hedge funds. Thus, using this strategy, investors usually face limitations in using leverage and derivatives.
This strategy can work best for investors who seek targeted index exposure that has active management. Other than that, this strategy also provides the benefit of hedging against the changing market environment or other trends.
Ways that 130-30 Strategy Works
The most common strategy in this fund is to get long 130% and short 30% (130 – 30 = 100%) of assets. To do that, investors need to range the companies, from best to worse on expected return, guided by their past performance.
After the manager gets the best-ranking stock, then the manager will invest 100% of the portfolio’s value and short sell the bottom ranking stocks, up to 30% portfolio’s value. After that, the manager will reinvest the cash earned from the short sales to top-ranking stocks.
