In November 2017, global equity markets posted their 13th-straight month of positive returns, as measured by the MSCI World Index. This was the longest winning streak in the index’s history, going back to its inception in January 1970.
Synchronized global growth, strong corporate profits, high operating margins, low interest rates, and low volatility have all been credited with aiding the market’s relentless ascent.
Given this environment, perhaps it’s not surprising that funds that can dampen portfolio volatility and truncate the downside when markets turn south haven’t exactly been flying off the shelf.
According to Morningstar, as of Oct. 31, 2017, assets under management for the entire Long/Short Equity category amounted to only $37.8 billion, a mere 0.4% of the assets under management in U.S. Equity and International Equity mutual funds and ETFs.
Further, over the trailing 12 months, long/short equity funds only took in $316 million on a net basis, while equity funds and ETFs brought in approximately $245 billion, or 775 times as much.
At a time when virtually all valuation measures for both public and private equities are at levels only partially exceeded during the tech bubble, and central banks around the globe are beginning to unwind their massive stimulus programs, it strikes us as more than a bit shortsighted that investors have been hesitant to embrace strategies with hedging properties.
But we get it, the S&P 500 returned 22.9% over the year ending in November, while the median long/short equity fund only returned about half that. What must happen though, for that kind of stock market performance to repeat?
Valuations are mean reverting. Profit margins are mean reverting. And economic growth and stock market performance aren’t highly correlated.
To believe that the market will simply continue to advance unabated is to believe that market conditions will get even better than what is already priced into asset values. Investing is always a forward-looking endeavor, and complacency and greed can be dangerous.
With that in mind, one of the primary advantages of long/short equity strategies is the ability to capture much of the upside when markets rise, while simultaneously dampening volatility and protecting against the possibility of a large loss.