Limiting exposure to extreme market moves


The higher the net market exposure of a stock portfolio, the more sensitive it is to the movements of the broader market.

 


Measure twice

There are two common measures of market exposure:

Gross market exposure indicates how much of a portfolio's assets are being invested in total, calculated by adding the portfolio's allocation to long positions and short positions. Gross market exposure can exceed 100% through the use of margin, derivatives or other investment strategies. For instance:

110% LONG SECURITIES + 90% SHORT SECURITIES = 200% GROSS MARKET EXPOSURE

On the other hand, net market exposure is calculated by subtracting the portfolio's allocation to short positions from its allocation to long positions. Revisiting the previous example,

110% LONG SECURITIES - 90% SHORT SECURITIES = 20% NET MARKET EXPOSURE

 

Market exposure: Understanding the math

Long/Short Strategies for Net Market Exposure

Market exposure and sensitivity

Net market exposure allows investors to anticipate how their portfolios may perform relative to the stock market. Under most circumstances, the higher the net market exposure, the more likely the portfolio will move in the same direction. While this similarity can be a good thing during upward trending markets, investors naturally seek to decouple their returns during downward trending or highly volatile periods.

Dialing exposure up or down

An investor's ideal net market exposure depends on his or her market outlook and risk appetite. There are numerous options available today to fine-tune market exposure. On one side of the spectrum, inverse strategies are managed to allow investors to participate in the inverse—or opposite—of market movements, while on the other end of the spectrum, traditional long-only strategies can substantially increase exposure to broad market movements. Because long/short strategies participate in both rising and falling markets, they allow investors to adjust their net market exposure with greater precision.

 

Different funds offer varying degrees of net market exposure

Different Funds for Net Market Exposure