Chris Huang

Christopher Huang, Investment Analyst at Zenith says “It is commonly held that long/short funds are as, or less risky than the market. While we certainly believe that quality long/short funds improve an investor’s risk/return profile relative to investing in the index, we do caution investors to understand and be comfortable with the notion of both net and gross exposure. We caution that market risk (net exposure) is not the only risk that investors should be cognisant of. Gross exposure (i.e. exposure to the manager’s stock picking skills) is also of paramount importance.” In Zenith’s 2013 Australian Long/Short Sector Report, we discuss the notion of whether long/short funds are more or less risky than the market.

“Active extension and variable beta funds have had solid returns in generally favourable equity market conditions over the past 12 months. Many of the funds we have reviewed in this sector have kept pace with the Australian equity market in the year to March 2013, with active extension funds benefiting more from the equity market rally than variable beta funds.”

“Many of the active extension funds we have reviewed have maintained close to 100% net market exposures which have allowed them to achieve returns close to that of the Australian equity market. In comparison, variable beta funds have generally struggled to outperform the market as their net exposures have been relatively low. Despite this, we continue to highly rate these type of funds as they have demonstrated a good track record of preserving capital in poorer market conditions.”

Huang also added, “We are also seeing an increasing number of funds taking advantage from shorting mining, mining services and energy related stocks which have performed poorly. This has aided in generating alpha. In this market environment, we believe that there are benefits of including both active extension and variable beta Australian long/short equity funds in an investor’s portfolio, as it allows investors in these funds to benefit from selecting companies likely to rise and fall in value (long and short positions respectively).”

Zenith’s approved Australian long/short equity funds (equally weighted), including active extension and variable beta funds, returned 16.3% relative to the market (S&P/ASX 300 Accumulation Index) return of 19.2% in the year to March 2013. Broken down by investment style, active extension funds returned 19%, which performed better than variable beta funds which delivered 12%. While returns achieved by the Zenith approved Australian long/short equity funds (equally weighted) were lower than the market, these funds achieved it with less risk, as measured by Standard Deviation (9.3% p.a. vs. 11.6% p.a. for the market) in the year to March 2013. By investment style, Standard Deviation for active extension funds for the year to March 2013 was 11.7% p.a. and 6.1% p.a. for variable beta funds over the same period.

From an initial universe of 35 Australian long/short equity products, 6 funds were rated “Highly Recommended”, 9 funds were rated “Recommended”, no funds were rated “Approved” and 20 funds were “Not Approved”.

Zenith’s complete Recommended List for the Australian Long/Short Equity Sector, broken out by investment style, is shown below:

Active Extension Funds (i.e. 130/30)

• BlackRock Australian Equity Opportunities Fund (MAL0072AU) – Highly Recommended
• BlackRock Wholesale Australian Share Fund (PWA0823AU) – Highly Recommended
• Perpetual Wholesale Share-Plus Long-Short Fund (PER0072AU) – Highly Recommended
• Regal Long Short Australian Equity Fund (AMR0006AU) – Highly Recommended
• AMP Capital Australian Equity Opportunities Fund (AMP1783AU) – Recommended
• Antares High Growth Shares Fund (PPL0106AU) – Recommended
• Arnhem Long Short Australian Equity Fund (ARO0019AU) – Recommended
• Ausbil Investment Trust – Active Extension Fund – Retail (AAP0008AU) – Recommended
• Grant Samuel Tribeca Alpha Plus Fund (ETL0069AU) – Recommended

• Bennelong Kardinia Absolute Return Fund (BFL0010AU) – Highly Recommended
• Perpetual Pure Equity Alpha Fund (PER0668AU) – Highly Recommended
• Evergreen Australian Equities Return Fund (EVG0001AU) – Recommended
• K2 Australian Absolute Return Fund (KAM0101AU) – Recommended
• PM Capital Australian Opportunities Fund (PMC0101AU) – Recommended
• WaveStone Wholesale Australian Equity Long/Short Fund (HOW0053AU) – Recommended

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“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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