Wealth Guide: Benefits of the Long-Short Fund in a Volatile Market

The “asymmetric return” profile makes a long-short fund one of the best platforms for building long-term wealth.

Basically, it reduces the risk of capital losses and opens upside opportunities to achieve equity-like returns.

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Ajay Vaswani, Senior Vice President at ITI Long Short Equity Fund decodes the strategy of a long-short fund and how it minimizes risk in a volatile environment:

Negative real returns:

Today, investors in India and elsewhere face a dual challenge. The first challenge is negative real returns on fixed income securities.

For example, for an investor, a fixed deposit investment in, say, the State Bank of India (SBI) generates an annual pre-tax return of around 4.5% when inflation is around 5-6% , which results in a negative real rate of return. .

While the purpose of an investment is to maintain or increase purchasing power, a negative real return means an investor is actually losing purchasing power by investing in fixed income securities.

Even though the Reserve Bank of India’s (RBI) rate-setting committee may raise policy rates by a few basis points in its upcoming meetings, the scenario won’t change much for bond investors as inflation looks entrenched. . This makes investing in fixed income securities less attractive.

Moreover, the value of the global stock of negative yielding debt had soared to over $16 trillion. This phenomenon of low or negative real returns was triggered by the policy actions of major global central banks led by the US Fed.

They injected a wall of money into the system and kept interest rates at multi-year lows, ostensibly to counter the pandemic-induced slowdown in the economy.

This policy, called “Quantitative Easing” (or QE), has contributed to raising the valuations of several assets, including equities.

Stretched stock valuations:

The second challenge facing investors relates to stretched stock market valuations and risks. Global markets, including Indian markets, tended to reach all-time highs until recently. The valuation of Indian stocks was also close to all-time highs. The sentiments of market participants were also exuberant.

It is undeniable that the main reason for the surge in equity valuations has been the unleashing of liquidity by the world’s major central bankers and the expansionary fiscal policy of the respective governments.

The flip side of this policy is that any change in market expectations of reduced levels of liquidity will drive stock prices down from their all-time highs.

While it’s hard to say how far this enthusiasm will take the markets in its bull cycle, it’s clear that the major theme for the markets going forward will be the unwinding of these quantitative easing measures by the major banks. power stations.

This will certainly trigger increased volatility and sharp declines in the stock markets.

Switch to hedge funds:

Given these challenges, large, sophisticated investors are turning to a hedge fund or a long-short equity fund.

Although there are several variations of long-short strategy funds available in the market, the main objective of a pure-play long-short fund is essentially to achieve the following objectives:

a. When the market goes down, protect yourself from the downside
b. Generate an equity-like return on upsides; and
vs. Over a full stock market cycle, beat the stock markets; the result is achieved with much lower risk and much lower volatility for the investor.

Essentially, this “asymmetric return” profile makes a long-short fund one of the best platforms for building long-term wealth.

Basically, it reduces the risk of capital losses and opens upside opportunities to achieve equity-like returns.

So, in volatile markets, it’s critical that investors understand why downside protection is important and how it adds value to long-term equity investing.

Remember Warren Buffett’s First Principle of Investing: “Rule #1 – Don’t Lose Money, Rule #2 – Never Forget Rule #1.” The math of declines means “you win by not losing”.

(Disclaimer: Opinions/suggestions/advice expressed here in this article are investment experts only. Zee Business suggests its readers consult their investment advisors before making any financial decisions.)

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