Long-Short strategies are often used by alternative investment managers. Hedge funds are typically limited partnerships, comprised of high net-worth investors, created to maximize return. Canadian hedge funds are managed by designated individuals who invest across a diverse range of products, not limited to stocks and bonds. Usually working from a predetermined set of strategies and behaviors, a hedge fund manager may distribute funds across many asset classes that include stocks, derivatives, real estate, currencies while frequently utilizing substantial leverage for potential higher returns.
Long-Short Investment Strategies
Canadian hedge funds are designed to make money for legally qualified, high net-worth investors during both up or down markets. Strategies include employing long/short investment strategies. With long-short investing, the intent is to be “long” with under-valued stocks and “short” with over-valued stocks, predicting that these will rise and fall, respectively. By doing so, the manager enhances the chances for profit by either winning on both the long and short or by “hedging” a loss against a gain.
LONG simply means buying a stock and, when the stock rises, selling and taking the profit.
Day 1: Buy 1,000 shares of ABC at $40 per share = $40,000. Hold the stock.
Day 5: XYZ shares have risen to $44 per share; Sell the stock. Profit =$4,000.
SHORT is borrowing shares of stock from a broker at interest, selling them, and holding the cash while waiting for the stock to drop. At a lower price point, the manager buys the stock, pays back the broker with an equal number of shares, and pockets a profit. Here’s an example:
Day 1: Borrow 1,000 shares of XYZ @ $40 per share. Immediately sell the stock for $40 and pocket $40,000.
Day 5: XYZ shares drop to $36 / share; Buy the 1000 shares of XYZ at $36 and pay $36,000. Pay back the 1000 shares of XYZ and pocket a profit minus commissions and interest. Profit = $4,000.
Hedge Fund and Long-Short Investing Risks
While this looks simple, there are still risks with long/short investing. What if, in the simple example above, XYZ actually outperforms ABC, creating a negative return?
Many hedge funds in the United States and Canada have failed either through over-exuberance of the manager, bad timing or poor due diligence. While hedge fund managers are well compensated when they produce positive gains, they could earn virtually nothing when the fund fails to perform.
If you have any questions about long-short investment strategies or if you would like to discuss about investing in a Canadian hedge fund, we invite you to contact us today. It will be our pleasure to answer your questions.