June 6, 2022 BARRON’S 15
only 18 have positive performance in
2022, and most have poor long-term
returns. (Even if you wanted to chase
Invenomic’s hot performance, the
fund is closed to new investors.)
Is there a simpler way to hedge a
portfolio in today’s volatile market?
Long -short funds tend to be expensiv e
and don’t do a tremendous amount of
shorting. The avera ge annual long-
short equity fund fee is 1.9 5%, includ-
ing shorting costs. Excl uding them, the
cost is 1.52%. An in ves tor can simulate
a long-short fund with two separate
funds for less—and more effectively.
The potential benefits of such a
strategy are twofold. The stock market
is down this year, and many experts
think a recession is inevitable, so a
hedge against further downside can
help protect your portfolio. Plus, a
two-fund long-short strategy can
target specific market trends like the
value-versus-growth stock perfor-
mance dichotomy we’ve seen this year,
which Invenomic has exploited.
Let’s sa y y ou lik e value stoc ks no w
but are bearish on the market overall.
Consider that the Vanguard Value
exc hang e-tra d ed fund (VTV) has an
annual 0.04 % expense ratio, while the
Direxion Daily S&P 500 Bear 1X
ETF (SPDN) charges 0.4 9%. The for-
mer tracks the CRSP U.S. Larg e Cap
Value Index; the latter pro vides the
daily in v erse of the S&P 500, rising
when the S&P 500 falls and vice versa.
A simple 50-50 portfolio of these
two ETFs would cost only 0.27%, and
would be up 5.3% in 2022, with the
Vanguard ETF down 0.7% and the
Direxion short ETF up 11.3%. The
average long-short mutual fund is
down 4.5% this year.
Though effective in 2022, such an
ETF pairing would be a blunt instru-
ment, and investors can hone their
strategies more effectively. For one
thing, a 50-50 long-short split isn’t
what most long-short funds do. To be
in Morningstar’s Long-Short Equity
category, a fund will “typically have
beta values to relevant benchmarks of
between 0.3 and 0.8.” Beta indicates
the sensitivity a fund has to the mar-
ket. A 0.8 beta indicates an 80% sen-
sitivity, so that if the market rises or
falls 10%, the fund rises or falls 8%.
A 50-50 long-short pair would be
closetoa0beta,or0%marketsensi-
tivity. T o have more upside potential,
you could have 75% of your portfolio
in a long fund and 25% in a short fund,
and target a beta of about 0.5. The 25%
short hedges 25% of your long port-
folio, leaving you 50% net long. You
could also switch from shorting the
S&P 500 to shorting tech—a poorly
performing sector in 2022—by short-
ing the tech-laden Nasda q 100 Index
with the ProShares Short QQQ ETF
(PSQ), up 22% this year.
The nice part is you have complete
control over the exposure. Addition-
ally, using two separate funds enables
you to harvest tax losses if the long or
short fund is declining—a likely sce-
nario, as the funds move in opposite
directions. You can’t do that with a
single long-short fund.
Of course, in a strong bull market,
the strategy will probably underper-
form, but having beta exposure
should capture some of the upside.
More-sophisticated strategies are
possible if y ou short funds or individ -
ual stocks yourself , instead of relying
on an in verse fund like Direxion ’s or
ProShares’. Yet there are shorting costs
and risks because the potential down-
side for short positions is unlimited. If,
sa y, an ETF rallies 200%, you’ve lost
double yo ur in vestment, although di-
versified ETFs rarely go up so much.
“Very high-beta stocks tend to
underperform in the long run, so I
would advocate that [investors] short
an index ETF” like Invesco S&P
500 High B eta (SPHB), says Harin
de Silva, a portfolio manager at All-
spring Global Investments who spe-
cializes in long-short strategies.
One appeal of shorting high -beta
stock s: A little goes a long way. A 20%
short position is plenty, with 80% long
in another fund. Tha t’s because high-
beta stocks fall more in downturns, so
you need a smaller short position to
hedge. For instance, during the pan-
demic crash in 2020 ’s first quarter,
Invesco S&P 500 High Beta fell 37.4%
while the S&P 500 dropped 20%.
T
o refine your strategy, you could
purchase an activel y managed
mutual fund or ETF on the long
or short side that will adjus t its
exposures based on mark et conditions.
This wa y, you aren’t relying on value
stock s to outperform the broad market,
as in the previous example .
There are three acti vel y managed
short funds that have prov ed effectiv e
in down turns: A dvisorS har es
Dorsey Wright Short (DWSH),
Leuthold Grizzly Short ( GRZZX),
and AdvisorShar es Rang er Equity
Bear (HDGE). Dorsey Wright Short
emplo ys a simple strategy of shorting
the 75 to 100 companies with the
weakest price momentum. If growthy
tech stocks are doing poorly, it shorts
them, but if the market turns and value
stock s start to underperform, it adjusts
to short them instead.
The fees on AdvisorShares Dorsey
Wright Short—3.68%—seem exorbi-
tant until you realize the management
fee is 0.75% and 2.46% goes to short-
interest expenses, which any short
investor has to pay.
There is also a hidden bonus from
shorting. When investors short a
stock, they borrow its shares and sell
them, hoping to buy them back later at
a lower price. They can invest the cash
they receive from selling the shares
and receive interest on it.
Rising interest rates, like we have
now, are bad for stocks but great for
cash investments, which yield more to
cover shorting expenses. It’s another
reason that now could be a good time
to employ this strategy.
B
How to Build Your
Own Hedge Fund
Long-short funds tend to be expensive and don’t do a tremendous
amount of shorting. But small investors have alternatives.
An investor
can simulate
a long-short
fund with
two
separate
funds for
less—and
more
effectively.
I
nvestors seeking to hedge their
portfolios in today’s volatile
market via all-in-one mutual
funds might be better off doing
it themselves.
It would be hard to find a
mutual fund investment cate-
gory with a wider division of returns
than Morningstar’s Long-Short Equity
this year. The category’s hedged
funds, which are supposed to protect
against downturns by shorting, or
betting against, certain stocks, have
become utterly unpredictable.
The Invenomic fund (ticker:
BIVRX), which bets on value stocks
and against growth, is up 46.7% this
year, while the RiverPark Long/
Short Opportunity fund (RLSFX),
which bets on high-growth stocks
and against low-growth ones, is down
46.3%. Of the 77 long-short funds,
By LEWIS BRAHAM
Illustration by George Wylesol