Altegris: Forget Active Long-Only Strategies, Go Long/Short

A new whitepaper from Altegris, Long/Short Equity: Choosing Alpha over Beta, makes the case for long/short equity investing as a viable alternative to actively managed, long-only strategies. The paper’s authors, Ryan Hart, CFA, CAIA, Portfolio Manager and Co-Director of Research & Investments, and Lara Magnusen, CAIA, Director of Investment Products, argue that beta exposure can be accessed through low-cost, passive indexing; that long-only strategies have too much beta; and that long/short equity strategies have and should continue to outperform long-only strategies. Here are the key points they make:

  1. The Role of Passive Indices – Traditional indexing strategies are long-only and provide exposure to beta. But since actively managed, long-only strategies contain all of the same components as passive indices, and since neither sell short, there is undue correlation between the two strategies.
  2. Double Alpha – Altegris makes the case that long/short is a superior way to pursue alpha, since it provides “double alpha opportunities” – alpha to the upside and alpha to the downside. Long-only active strategies can at best seek to mitigate loss during downturns, while long/short strategies can pursue profits in any market environment.
  3. Stock Selection – Long/short portfolio managers typically use bottom-up, fundamental analysis in an attempt to identify stocks they think will outperform, as well as stocks they think will underperform – a long/short fund can buy the former and short-sell the latter. Not so in a long-only fund.
  4. Exposure Management – Long/short managers can employ “active exposure management,” potentially adjusting between net-long and net-short positioning, and possibly using leverage to achieve exposure of greater than 100%. Long-only funds, by contrast, typically carry long exposure of roughly 80%, do not use leverage, and can at best pair back their holdings in favor of cash during long downturns.
  5. Performance Expectations – According to Altegris, this dynamic shift of positioning has allowed long/short equity to outperform the S&P 500 Total Return (TR) Index by more than double over the past 25 years. The chart below demonstrates the performance of long/short equity in comparison to the S&P 500 TR Index, beginning with a hypothetical $1,000 investment in 1990 (see whitepaper for detailed disclosures):
    Altegris Long-Short Investing
    Throughout a full market cycle, long/short equity strategies have outperformed since 1990, and Altegris expects this to continue to be the case for well-managed long/short equity funds.
  6. Risks – Altegris does caution investors that short-selling has certain inherent risks that are foreign to long-only investors. Selling “short” refers to selling something you don’t own – in order to make the sale, you have to “borrow” the security you want to “short.” This amounts to “leverage,” and with added leverage comes increased risk.

Altegris says it expects “well-managed” long/short equity funds to outperform long-only, but therein lies the rub: alpha is a zero-sum game, and some long/short funds will win while others are likely to lose. For this reason, manager selection is truly key.

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