Lonsec releases its Australian Equity Long/Short Sector Review


Lonsec’s review of the Australian Equity Long/Short sector encompassed 12 funds across a diverse range of products,  which Lonsec has broadly categorised as either ‘beta 1’ or ‘variable beta’. Lin Ngin, Senior Investment Analyst responsible for this review explains the difference between these funds.

“Beta 1 style funds will typically maintain a net equity exposure of close to 100%, with the proceeds from short selling reinvested in their long positions. Short selling is primarily used to enhance overall fund returns and comes with increased market risk.”

“Variable beta style funds may utilise a broad range of strategies including short selling, gearing, derivatives and cash in order to adjust their net equity position in line with the investment manager’s market outlook.”

Of the 12 funds reviewed, none attained Lonsec’s top rating, Highly Recommended.

Sector themes and observations

High quality PMs entering the sector

While the universe has not increased all that dramatically, Lonsec is of the opinion that it has evolved with the introduction of a number of competing teams with strong skill sets and experience. “Historically the retail long short sector has been dominated by successful long only managers launching active extension or long short strategies,” commented Ngin.

“Lonsec believes that the shorting element is a specialist skill set and has tried to differentiate between solid long only investors versus investors with extensive track records in shorting.”

Post the GFC, the quality of personnel within the long short space has increased, especially at the portfolio manager level.

“We have seen a number of hedge fund investment professionals gravitate to the retail space, leading to greater sophistication and greater dispersion in portfolio manager skill sets and short selling experience,” said Ngin.

Key person risk is high

Key person risk for many managers is relatively high, given the additional specialist skill set required for the effective implementation of the shorting component of a portfolio.

“While we see this as a potential risk, at Lonsec we believe that key person risk is often worth taking,” said Ngin. “That said, in the event that a key person ceased to work within an organisation, the rating of the Fund would be reviewed.”

Stop losses – stopped out

While the market only returned 3.8% for the year to May 2011, it should be noted that this was a relatively volatile period. As a result, it wasn’t unusual to see managers being ‘stopped out’ of their short positions. Managers that employed less rigid approaches to their stop losses were more likely to benefit from this volatility as they were less likely to be stopped out of positions that would later turn profitable.

“While this strategy may have worked in the favour of managers with the less rigid approaches to their stop losses over the last 12 months, Lonsec acknowledges that good risk management in long/short investing is important and that improperly managed short positions can result in significant losses,” observed Ngin.

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