Should I invest in long/short strategies?


In today’s volatile market environment, a traditional long-only strategy — where the goal is to buy low and sell high — may not provide you with the returns or diversification you need. You might be able to enhance your portfolio by adding alternative strategies such as long/short strategies.

Impact on Market Risk

Because short positions – where you sell the security first, hoping to buy it back at a lower price – benefit from market moves in the opposite direction of those that benefit long positions, combining the two of them can be used to help reduce your overall market risk.

The chart below illustrates the net market exposure of a hypothetical long/short strategy.

Front of Chart

Net market exposure of a hypothetical long/short strategy

As the chart shows:

The “long” side of a long/short strategy is invested in the traditional way – you buy a security and later sell it. You make a profit when the security increases in value

In the “short” side, you “borrow” a security and immediately sell it, hoping its value will fall. Later, you buy the security back for a, hopefully, lower price, close your position, and keep the difference between what you received when you sold it and what you paid when you bought it back. You profit when the security decreases in value.

By combining long and short strategies into one portfolio, you reduce your net market exposure. This illustration shows a 20% net market exposure — 90% short positions subtracted from 110% long positions — but the amount of market exposure will vary by strategy and over time.

Impact on Returns

In addition to reducing risk, a long/short strategy may help enhance your portfolio’s returns.

The chart below uses a hypothetical $10,000 investment to compare the returns of stocks, bonds and a long/short strategy over the 15-year period from 2000 to 2014.

Back of Chart

Comparation of the returns of stocks, bonds and a long/short strategy over the 15-year

As the chart shows:

A hypothetical $10,000 investment in bonds or long/short would have grown close to $25,000 over 15 years.

Since "short" portfolios may be more able to profit in a declining market, long/short strategies may offer greater downside protection than traditional "long-only" portfolios. This can help long/short strategies perform better over time.

Investing involves risk, including possible loss of principal.

Keep in mind that a long/short investment strategy may not perform as expected and the value of securities purchased long could decrease and/or the value of securities sold short could increase, thereby multiplying the potential for losses.

Theoretically, stocks sold short have the risk of unlimited losses. Any losses may or may not be offset by investing short sale proceeds in other investments.

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