Historically, institutional investors have allocated to long-short equity hoping for attractive returns that are not too dependent on market exposure. In the past, institutions have accessed long-short equity via hedge funds, but more recently some are looking to mutual funds for their long-short allocation.
One of the reasons for the disparity between retail and institutional funds has been the appreciable difference between both the risk and return characteristics. When considering total returns for long-short equity, hedge funds have historically had the upper hand when compared directly to their mutual fund counterparts. As shown in the table below, the HFN Long-Short Equity Index has outperformed the average long-short equity mutual fund over every trailing period with the exception of the past three years. Over the last 15 years, the difference is substantial at 7.43% per year net of fees.
However, how much risk, or beta exposure, are the two groups taking? For the latest 10-year period, the average mutual fund beta of 0.53 has been considerably higher than the average institutional hedge fund beta of 0.38.
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The key question though is how much alpha, or return, from security selection, or skill, have managers in both groups provided? The results reveal that hedge fund long-short equity managers have produced more alpha than the average long-short equity mutual fund manager for all time periods, ranging from 0.27% over the last three years to 6.14% over the last 15 years.