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Guide to investing in long/short funds

Long/short funds are designed to maximize the upside of markets, while limiting the downside risk. For example, they may hold undervalued stocks that the fund managers believe will rise in price, while simultaneously shorting overvalued stocks in an attempt to reduce losses. Long/short funds also use other strategies aimed at mitigating market volatility, including leverage and derivatives.

Different types of long/short strategies

There are various types of long/short strategies, including:

  • Sector specific. Focus on a certain sector or industry, such as banking, technology or pharmaceuticals.
  • Geographic. Invest in specific markets or regions of the world, such as the U.S., Europe or emerging markets.
  • Market neutral. Use strategies aimed at minimizing the fund’s sensitivity to outside market volatility.

Potential benefits

Some of the potential benefits of a long/short investment strategy include:

  • Portfolio diversification. Unlike long-only strategies, in a long/short investment strategy, managers buy stocks and bonds that they expect to outperform the market, while taking short positions in assets they expect will underperform. This expands the potential investment universe offering the potential for a more diversified portfolio that is less correlated with equity and fixed income markets.
  • Excess returns. Because long/short strategies rely less on upward markets, there is the potential for returns from both rising and falling prices. Investing in long/short strategies presents the opportunity for significant losses including in some cases, losses which exceed the principal amount invested. There is also the possibility that long and short strategies could both fail, thereby increasing volatility and potential losses.

Long/short mutual funds offer investors the opportunity to take advantage of a long/short investment strategy, while maintaining broader investment flexibility than long-only funds and ready access to their capital. Like other mutual funds, long/short mutual funds offer daily pricing and the ability to liquidate your investment at any time.

Why consider BlackRock?

The investment teams behind BlackRock's Global Long/Short Equity Fund use “big data” to find hidden opportunities that others might miss. This offers investors a distinct advantage and an opportunity to diversify their portfolio and potentially benefit from returns that are independent of the global markets.

BlackRock Global Long/Short Credit Fund’s global focused, long/short strategy may lead to greater portfolio diversification, demonstrated by the fund’s historical low/negative correlation to traditional fixed income.

What are some risks associated with long/short mutual funds?

Because of the higher associated trading costs, long/short mutual funds tend to have higher fees than traditional mutual funds. For example, long/short equity funds averaged a 1.9% expense ratio, compared to a .57% expense ratio average across all mutual funds, according to 2016 data from Morningstar. In addition, the funds make use of more complex investment strategies and can be considered riskier than traditional mutual funds.

What are some of the myths associated with long/short mutual funds?

Because long/short strategies were traditionally associated with hedge funds and institutional investors, some people assume there's a high barrier to entry. But that's not the case. In fact, long/short mutual funds are generally available to all investors and usually have a low minimum investment — $1,000 or less. Long/short hedge funds can offer greater investment opportunities beyond those of mutual funds, but typically require higher investment minimums (e.g., $100,000+) and may be as high as $1 million or more.

Important considerations regarding long/short funds

Long/short funds may be a great addition to your investment portfolio. But before you dive in, make sure that you consider these factors:

  • Fund performances vary. The strategy of any long/short fund is set by the portfolio managers, and the performance of individual funds varies widely. Research your fund options and understand the strategy behind them before you invest in any one.
  • Personal risk tolerance. Because these funds can include short positions, there's the potential for significant losses. Establish your own risk tolerance and then invest accordingly.
  • Investment goals. Talk to your financial advisor about your goals, and whether a long/short fund makes sense for your return expectations and overall investment strategy.