Monday Morning Memo: Long-Short Equity Funds and a Low Volatility Environment

Lipper’s Jake Moeller examines the performance of long-short equity funds in 2014 and how popular they are in European fund of funds holdings. All performance figures are in EUR.

Reuters/ Luke MacGregor

Long-short equity funds, once the preserve of sophisticated investors and hedge funds, have become increasingly popular as both awareness of how these products work and product accessibility improves. They are not however a homogenous product set. The overall objective of most funds is to combine market return from market beta, whilst adding incremental value with selective stock picking with downside protection. There are a number of ways to do this including physical buying and shorting of stocks, using equity or equity index derivatives to offset long positions, or the use of options to create a synthetic portfolio.

Whatever process is used, investors are generally seeking to reduce volatility by including exposure to a long-short strategy. As at 5 September 2014, the CBOE Market Volatility Index (Vix) is trading at US$12.09. On 3 Feb 2014 it reached its highest value for the year at US$21.44. By contrast in November 2008 it reached a peak of over US$80. Is there any advantage to including these funds in a portfolio in such a comparatively low volatility environment?

Table 1. Six Month Performance of the CBOE Market Volatility Index (Vix)

Source: Eikon.

The dispersion of returns within long-short equity sectors has been considerable. The best performing fund over 1 year to 31 July 2014 has been City Financial Absolute Return Equity with 47.1% whilst Montlake Pegasus UCITS EUR Ret Acc returned -8.9%. By contrast, over the same time period, the Lipper Global – Europe Equity sector has returned 12.7% and the Lipper Global Alternative Long/ Short Equity – Europe sector 4.8%. Neither of these funds appears in the European buyers charts.

Table 2. One Year Performance of the Lipper Global Alternative Long/ Short Equity V Lipper Global Equity Europe Sectors

Source: Lipper

The most popular choice for European fund of funds managers with 34 buyers is Alken Fund – Absolute Return Europe-I which for the one year to 31 July 2014, has returned 4.6%. Schroder GAIA Egerton Equity C Acc Eur has come in second with 25 buyers and has returned 4.4%. At the other end of the performance spectrum top performer over 1 year, Henderson European Absolute Return Inst Acc which has returned 27.55% has only 1 astute European buyer, but a number of good performing long-short equity funds have been identified: R Parus I Euro Unhedged has returned 10.02% to year ended July 2014 and been spotted by 13 buyers. Henderson UK Absolute Return has returned 16.6% and been purchased by 15 European buyers.

With the vast majority of European fund buyers selecting equity long-short funds that have underperformed the Lipper European Equity sector over 1 year (some 90 in total), there may well be a number of investors who hope that their chosen fund-of funds sees an imminent increase in the Vix price.