long short mutual funds

long short mutual funds

Definition of a Mutual Fund's Short- & Long-Term Holding Period

When you receive the Form 1099 for your mutual fund's capital gains distributions, those payouts will be divided into long- and short-term gains for you to report on your tax return. The mutual fund company uses the same rules you would to determine whether a gain on an investment is long-term or short-term. A fund pays out the whole year's worth of the two types at the end of the year.

The tax rules define short-term as an investment holding period of one year or less. Selling an investment that was held less than a year results in a short-term gain or loss. Investments held longer than one year and sold for a profit will produce long-term capital gains. The long- or short-term cutoff applies to investments held by a mutual fund as well as to your personal investments.

A mutual fund must distribute net capital gains to shareholders at least once a year. Most mutual funds total up short- and long-term gains for the year and make the distributions during the last couple of weeks of December. The distributions reflect all of the realized profits the fund earned for the year. Capital gains distributions are the profits net of any losses the fund incurred on its portfolio.

A mutual fund's determination of short- and long-term gains is based on how long it's held an investment. This might not correlate with how long you have owned shares of the mutual fund. You might have owned a fund for only a few months yet receive a long-term capital gain distribution. Conversely, a fund you've owned for years might pay you short-term capital gains distributions.

The important difference between long- and short-term capital gains is that they are taxed at different rates. Reported short-term gains will be taxed at your marginal income tax bracket rate. Long-term gains are taxed at a lower rate. As of 2012 the maximum federal tax rate on long-term gains was 15 percent, compared to a top regular income tax bracket of 35 percent. Although you have no control over whether a mutual fund generates short- or long-term gains, you do have control over which funds you choose as investments.

What is a long-short mutual fund?

A Long-Short Fund is a mutual fund that holds investments long and in addition it sells securities it does not own (short). The goal of a long-short fund is to find investments anticipated to go up, and find investments anticipated to go down, and invest in both in an attempt to increase returns. For example, if an investor puts $100 into a long-short mutual fund, the fund manager will generally take the whole $100 and invest long in assets he thinks will do well. Then the manager will use this equity as margin to open a short position and sell assets he thinks will do poorly. When he shorts these assets he will receive cash, say $30 for this example. He would then use this $30 to invest long into more assets, so in total he would have $130 long portfolio and $30 short portfolio, effectively using your $100 initial investment to make $160 worth of investments. This type of long-short fund in the example is called a 130/30 mutual fund.

Traditionally, the majority of mutual funds are long-only, meaning if something was considered undervalued, it would be invested in, and if a security was thought to be overvalued, the only thing investors are able to do is to avoid investing in it. Long-short funds allow the manager more flexibility to act on his analysis. However, investors should be aware of the risks associated with investing in this type of mutual fund. If the fund manager made good investments, the combination of a long and short portfolio would leverage the funds return upwards. On the other hand, instead of just picking stocks that managers think will go up, they also have to predict which stocks are going down, which means the managers stock picking skill is very important. If mutual fund historical performance is any indication, it is extremely difficult to find a fund manager that consistently outperforms the market in long-only funds. Finding one that can predict stocks that go up and stocks that go down may be even more challenging. (Learn more about which management style might best fight your investment goals, read Mutual Fund Management: Team Players Or All-Stars?)

This question was answered by Joseph Nguyen.

Long-short mutual funds are market neutral, dividing their exposure equally between long and short positions in an attempt to earn a modest return that is not tied to the market's swings. Other long-short portfolios that are not market neutral will shift their exposure to long and short positions depending upon their macro outlook or the opportunities they uncover through research.

The strategy seeks capital growth and income. For example, one strategy will invest in a diversified group of assets, such as investing 55-65% of its assets in equity securities (including stocks and equity funds) and 35-45% in fixed income securities (including bonds and fixed income funds), and cash and cash equivalents (including money market funds). For temporary defensive purposes during unusual market conditions or for liquidity purposes, the fund has the option to invest up to 100% of its assets in cash, money market instruments, and other short-term obligations.

Long-short mutual funds, which bet for and against stocks at the same time, offer ways to seek profits, protection or some of both. Many of them do not try to beat the stock market, they try to lock in most of the market's gains while paring losses when it falls; although typically with higher fees.

There are many different kinds of long-short funds. The example I used above uses a middle-of-the-road approach. On the conservative end, a "market neutral" fund uses positions designed to negate market movements entirely. Investors make money only if the manager buys and shorts the right stocks.

Market-neutral funds are not designed to generate big gains. They aim for low correlation, or for moving independently of the broad market rather than with it, a benefit during market volatility when all assets can trade similarly.

There are plenty more strategies than these that extend to different asset classes or use different tools, like options, to achieve their targets.

The biggest drawback are usually the fees. The average expense for the long-short category as a whole is more than 2% of assets per year, compared with an average of 1.3% for U.S. stock funds.

Long-short strategies are best suited to investors who expect low returns from stocks in coming years, because these strategies do not rely solely on market returns. In this environment, the best funds might be those that seek to reduce stock market exposure without eliminating it. The goal is to get most of the market's returns when stocks go up, while paring the losses when stocks tumble.

The problem with these funds is that ambivalent investors might find comfort in them, whereas any investor who is bullish or bearish could likely have better options elsewhere.

Long-Short Mutual funds can be a beneficial piece of your portfolio, if you are the stage in life where you are looking for less volatility or you're generally worried about the future of the equity markets. As mentioned in previous posts, long/short funds are picking investments to buy (long) and investments to sell (short). This does not have to be individual securities, as long/short managers can short large markets or even sectors they believe are out of favor. The purpose of adding a long/short fund to your portfolio is diversification through low correlation. In other words, you are looking for a fund that will zig when the market zags. Correlation doesn't have to be negative, because you want to still make money when the market is going up, but you want a fund with the flexibility to take risk off the table or even make money when equities are falling. As such, the returns will not look anything like the S&P 500 and should be evaluated over a 5 - 10 year period.

In our firm, we have a couple of different long/short funds that we use. For those investors looking to take more risk we use one with a higher standard deviation closer to 10. For those clients that are moderate risk, we use a different long/short fund with a standard deviation closer to 4.5. These numbers are important when you are deciding how much risk to allocation to an alternative strategy like long/short funds. Furthermore, since these funds are actively managed you need the ability to see how much bang you're getting for your buck. Using Morningstar you should be able to find the Treynor Ratio which is a measure of risk-adjusted return. You can use a Sharpe Ratio as well, although Sharpe Ratio is usually used to value the risk-adjusted return of an entire portfolio and not just a single manager. Given the higher fees you want to make sure you are being provided a positive risk-adjusted return. To learn more about the Treynor Ratio click here to view an article from US News & World Report.

If you are a young investor and just getting started, then a long/short fund is not necessary. Take advantage of dollar cost averaging and buy low cost investments. If you're getting close to retirement or are in retirement then these types of investments can have value. Be sure to evaluate a fund with a long enough track record to see how well they have performed in various market conditions. As these funds are successful they eventually reach capacity and close to the public, but check with your advisor if they have access to some they would suggest.

There is already a great answer explaining what a long-short mutual fund is. Allow me to answer a question that wasn't asked, but should be answered:

"Should I use a long-short mutual fund to invest?"

Why not? Because you're likely not going to get relatively good investment returns.

Why is this the case? To be successful, a money manager using a long-short strategy must be exceptionally skilled. Unfortunately, this is rarely the case. In the end, you're likely better off using a conventional, low-cost invest strategy such as a broad market index fund (like an S&P 500 index fund, etc.).

There are a few reasons why:

1.) Cost: Using an actively-managed fund is rarely cheap. This means you pay a lot of money to a manager that may (or may not) beat the performance of a typical low-cost index fund. It is highly unlikely that paying a money manager a tidy will enable him to outperform an index fund.

What are the odds that the money manager that you pick will outperform an easily accessible low-cost index fund? About 17%. Said another way, you have about an 83% chance the low-cost diversified index fund will outperform active strategies - active strategies such as a long-short fund.

2.) Limited Upside, Infinite Downside: When you traditionally invest in stocks, there are two directions the value of your stock could can move: up or down. But, it's the degree of this movement that matters.

When investing in stocks, you have literally unlimited potential for your invest return to increase forever, indefinitely. In short, you are looking a return potential of infinity.

That sounds pretty good, right? Who wouldn't want an investment return with the potential to be infinity? But, you could also lose your entire investment. Here's an example:

Bob invests $100 in the stock of COMPANY A. COMPANY A goes bankrupt. Bob loses $100.

Charlie invests $100 in the stock of COMPANY B. COMPANY B invents a new widget. This sends the price of the stock soaring. Charlie's investment return is literally infinity.

When you traditionally invest in a stock, it is a risk worth taking. You could lose $100, but your investment return can literally be infinity.

Investing in stocks traditionally is known as going "long9quot; a stock. This is the "long9quot; portion of the long-short mutual fund.

When you short a stock, you now have limited upside potential and infinite downside. That's not a very attractive investment. Let's use an example to drive this point home:

Larry shorts the stock of COMPANY A. Since COMPANY A goes, bankrupt, Larry gets $100.

Mark shorts the stock of COMPANY B. Since COMPANY B invents a new widget, sending the price of the stock soaring, Mark faces infinite capital calls. This means that Mark must keep putting more money into his investment account - just to see that money disappear as the price of COMPANY B stock continues to rise.

In summary, when you go long a stock (the conventional way to invest), you have infinite return potential and only risk the amount of your original investment (i.e. $100). When you short a stock, you have limited upside (the current price of stock), but infinite potential for loss. That's simply not a good deal.

3.) Active Manager Success Fades with Assets: If you've come across a successful actively-managed mutual fund, chances are that tomorrow the fund will be a loser. Why is this case? And why does this happen? Too much money.

Warren Buffett - one of the most successful investors of the world - now has this very same problem: too much money. You see, there are only so many good investment opportunities available. So, what happens when an investment manager has more money to invest than there are good things to invest in? Does the manager just sit on the cash waiting for the next great thing to come along? Unfortunately not. Mutual fund managers must invest the cash they have. And if, they have more cash than there are good things to invest in, those managers are forced to invest in not-so-great investments.

Let's use an example to illustrate this point:

Michael the Mutual Fund manager is given $100,000 to invest. He finds a great investment opportunity: COMPANY X stock. Michael the Mutual Fund manager invests the $100,000 in the stock of COMPANY X. The stock price of COMPANY X goes soaring - and Michael the Mutual Fund manager looks like a genius.

Because of his success, Michael the Mutual Fund Manager is featured in all sorts of financial media publications. Because of all the attention, investors clamor to invest in Michael's mutual fund. Michael the Mutual Fund Manager now has an additional $100,000,000 to invest.

Unfortunately for the new investors, there simply aren't any good investment opportunities available. But, Michael the Mutual Fund Manager must invest the $100,000,000 he was given. He's not allowed to simply sit on that much cash. So, Michael the Mutual Fund Manager invests in COMPANY Y, and COMPANY Z. This is despite Michael knowing that COMPANY Y and COMPANY Z aren't great investments. But, Michael has no choice. He must invest the money he has.

The results are predictable. Michael's Mutual Fund now shows poor performance. The new investors in Michael's Mutual Fund are disappointed. Those new investors would have been better off with a low-cost index fund.

To wrap it all up, a long-short mutual fund is simply not an appropriate investment for practically everyone because of:

Hedge Fund Blogs From HedgeCo.Net

The market downturn last year has led mutual funds to begin testing new strategies to produce gains with lower risk. Many managers are trying to replicate the methods used by long/short hedge fund managers. By finding negatively correlated positions, fund managers are able to offset losses with gains from other assets in the portfolio.

“130/30” funds short securities valued at 30% of the value of the assets in the fund, and can use the proceeds to purchase long positions in other securities, allowing the fund to invest 130% of the fund’s value in a long position. For instance, if the fund manager believes Visa is a superior stock to Mastercard and has a $1,000,000 fund, he could short Mastercard for $300,000 and use that $300,000 plus the $1,000,000 he has in the fund to buy $1,300,000 in Visa stock. Now the fund manager has a net $1,000,000 long position because he is holding $1,300,000 in a long position and $300,000 in a short position.

If the assumption about Visa outperforming Mastercard is correct, and the market is up, The gain on the extra $300,000 in the long position is higher than the loss on $300,000 short position. If the market is down, the gain on the $300,000 short position will be higher than the extra $300,000 in the long position and offset some of the loss on the whole long position.

A long/short fund can be similar to market neutral funds if the size of the investments in the long position equal the short position investments. For example, if a long/short fund manager believes that Coca Cola is a better stock than Pepsi Cola and puts $1,000,000 into a long position on Coke and sells another $1,000,000 in a short position on Pepsi, he has taken a market neutral position because he has net zero position.

The purpose of a long/short fund is to create stable returns, but there is a downside. In the Visa/Mastercard example above, the long/short fund doesn’t make nearly the amount of gains as a long position during an aggressive bull market. Also, the profitability of a long/short fund is predicated on picking one investment to outperform the other. Like market neutral funds, there is the unique risk in long/short positions called “beta mismatch”. If the beta of the long position is larger than the short position, a market downturn should cause the long position to lose more, as market moves affect the long position more. Furthermore, if the beta of the short position is larger, a market upswing should increase the short position’s loss more than the long position’s gain.

While long/short funds can be used to decrease market risk, fund managers can reduce other types of risks by making “paired trades”. Using the Coke/Pepsi example from above, the fund was protected whether the market moved up or down. Also, the fund was protected even if the soda industry moved up and down. By using this “paired trade” model, fund managers can hedge against market swings in particular sectors, industries, regions, and currencies.

Long short mutual funds are a type of mutual fund which uses strategies that will maximize total return. These funds are less sensitive to stock market drops. They are similar to hedge funds, but are more regulated. This limits the risks taken by the average investor.

Unlike hedge funds, these funds are available to the public. They have regulations that determine how much risk a fund can take. While this limits how much the fund will make, it prevents the fund from collapsing. This makes them more appealing to try.

Some of the strategies used are leverage, derivatives, and short positions. Leverage allows the fund manager the ability to increase his stock purchases. Derivatives are contracts based on an underlying asset affected by future events. (If said event occurs, the stock contract will be worth this much.) Short positions, or short selling, is used to offset a stock that is not performing well with the hope that it can be repurchased at a lower price, and thus reduce the loss. The law limits how many derivatives and short positions that can be taken. It, also, regulates how much leverage the fund may contain.

The fund manager watches the stock market trends. When there is a downturn in the market, he will use specific strategies to keep the fund from feeling the effect. This gives a buffer to the fund, and allows the market time to recover. When there is an upturn, the manager can take advantage of it. By staying proactive, he will provide a much better return to the average investor.

Most funds have several advantages. They have a minimum investment of $1,000.00. The investor will not be locked in for a set period of time. The fees are considerably less.

In short, these mutual funds are the best of both worlds. The benefits of a hedge fund enhanced profits, while limiting the excessive risks. They have a better return than the standard mutual fund, too. Fund managers look for the best possible return on the money invested. These advantages will allow the investor to be able to weather the stock market changes, and thus grow his portfolio.

3 Long/Short Mutual Funds To Hedge Market Volatility

After an unprecedented stretch of calm during summer, equities see-sawed this month with investors anticipating interest rate decisions from the Federal Reserve and Bank of Japan today. On top of that, developments like discouraging corporate earnings, stretched valuations and presidential elections are expected to keep markets choppy (read more: Top 5 Low Beta Stocks to Sail through a Volatile Market).

To sidestep roller-coaster rides, invest in Long/Short mutual funds. Why so? Because Equity long/short funds seek to gain from both winning and losing stocks, irrespective of the current market scenario. These funds use conventional methods to identify stocks that are either undervalued or overvalued. They profit from shorting overvalued stocks and by buying undervalued stocks. Weights are subject to change and are dependent on management’s view of the market.

For example: Say an investor buys a long/short mutual fund for $100, the fund manager will then invest it in assets that are expected to do well. The manager shorts $30 in stocks that are believed to be overvalued. In the process, he receives $30 in cash. He will now use that $30 to buy more assets with an upside potential. So, now he has a total of $130 invested in long positions and $30 in short positions. This type of long/short fund is called a 130/30 mutual fund.

Below we share with you three top-rated, long/short mutual funds. Each has earned a Zacks Mutual Fund Rank #1 (Strong Buy) and is expected to outperform its peers in the future. Investors can click here to see the complete list of long/short mutual funds, their Zacks Rank and past performance.

Boston Partners Long/Short Equity Investor BPLEX seeks long-term capital appreciation. BPLEX invests the majority of its assets in equity securities. The fund invests in long positions in stocks identified by the Adviser as undervalued, but it will not exceed approximately 125% of its net assets. BPLEX also takes short positions in stocks that the Adviser has identified as overvalued. Boston Partners Long/Short Equity Investor has a year-to-date return of 10.8%.

Robert Jones has been its portfolio manager since 1998.

Glenmede Long/Short GTAPX invests the majority of its assets in long and short positions with respect to equity securities like common stocks of U.S. public companies. GTAPX will purchase stocks that have market capitalization within the range of any stock listed on the Russell 3000 Index. Glenmede Long/Short seeks total return and has a year-to-date return of 0.7%.

As of April 2016, GTAPX held 226 issues, with 1.37% of its assets invested in Newmont Mining Corp (NYSE: NEM ).

Federated Ultrashort Bond A FULAX seeks total return. FULAX mostly invests in investment-grade, fixed-income securities. FULAX also invest a maximum 35% of its assets in noninvestment-grade, fixed-income securities. The fund may invest in government securities that are supported by the credit of the U.S. government. Federated Ultrashort Bond A has a year-to-date return of 1.1%.

Randall Bauer has been its portfolio manager since 1997.

To view the Zacks Rank and past performance of all long/short mutual funds, investors can click here to see the complete list of funds.

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