As 2008 played out, filled with bad news from the hedge fund industry, the practice of shorting stocks--a popular hedge fund strategy--got dragged through the muck.
But many investment pros continue to believe shorting makes sense--some of the time--for some investors. There are risks, of course. The maximum someone can lose from a long equity investment is 100%. There is no maximum someone can lose on a short equity investment. For this reason, most advisors suggest shorting only a small portion of one's portfolio.
"Those investors who don't believe it's appropriate to use both long and short strategies are not using all the arrows in Wall Street's quiver. They clearly don't understand that markets rise and fall, and it's useful to be able to profit in both types of markets," says Daniel Strachman, author of Essential Stock Picking Strategies: What Works on Wall Street and an investment blog: www.hedgeanswers.blogspot.com.
Putting aside the mysterious world of hedge funds, there are plenty of ways for individual investors to benefit from shorting strategies without shorting stocks themselves. There are regulated mutual funds that practice long/short strategies (examples are in the tables on this page).
Interestingly, as the S&P 500 fell 37% in 2008, the average long/short mutual fund declined only 15.38%, and the best performers posted double-digit gains.
The top performer last year was the GMO Alpha Only fund, which doesn't appear to have been socked with redemptions. Assets under management as of November 30, 2008, totaled $1.9 billion, unchanged from December 31, 2007. The fund takes long/short positions not only in stocks, but also in currencies.
Another double-digit gainer in 2008 was the Highbridge Statistical Market Neutral fund. This fund is part of the JPMorgan family and has had the same management team in place since November, 2005. The fund's outperformance may be attributed in part to its large cash position, as high as 17.85% as of September 30, the most recent period for which holdings have been reported.
Beth Piskora, managing editor Standard & Poor's Equity Research, is at email@example.com.