Handbook of Hedge Funds

7

Long/Short Equity Strategies

Stock picking is like playing the lottery. It is definitely a game worth winning. But is it a game worth playing?

In the world of hedge funds, the term “equity strategies” is almost synonymous with long/short equity, also known as “equity hedge”. As already mentioned, the long/short equity investment approach finds its roots in the original Alfred Winslow Jones model. It consists primarily in combining long and short positions in equities, resulting in portfolios that have reduced market risk.

Long/short equity funds have been around for decades and now represent the biggest segment among non-traditional investments. Most long/short equity managers apply the same fundamental analysis as traditional funds, with the difference that they can – at least in theory – generate profits even in declining markets. However, over the years, the initial strategy has evolved to capture various sources of return and adopt different investment approaches. For instance, sector funds have emerged; some managers have evolved towards more quantitative strategies; others have adopted a more active approach and drifted towards private equity or activist techniques. None of these changes is really revolutionary, but they show that hedge funds are indeed reinventing themselves whenever necessary.

At first glance, because long-only and long/short strategies both use common stocks, one may think that they are closely related. But in reality they are quite different. First, ...