A Long/Short Bridge Between Stocks and BondsLearn more about this firm
Frothy stocks and well bid bonds can undercut portfolio performance if rates move higher, though long/short equity strategies can support long-run returns.
Can long/short alternative equity strategies work as a “bridge” between equity and fixed income? It’s an interesting question recently posed to us by a wealth advisory team. Both asset classes become vulnerable to higher interest rates when valuations are rich.
Historically, the answer is yes: long/short equity strategies have helped protect portfolios, particularly when the stock market became volatile or downward trending.
To be sure, that hasn’t been the case lately. Compared to “core” asset classes, hedge fund returns disappointed over the last three turbulent calendar years. The HFRI Equity Hedge Index returns ranged from a negative 1.0% to a positive 5.5% during the period. That contrasts sharply with the S&P 500 Index’s double-digit gains in 2014 and 2016, bookmarking a near flat 2015, amid high dispersion in U.S. fixed income returns.
But when viewed over a longer time horizon, the picture changes dramatically. Long/short equity strategies have outperformed, and with lower volatility. In the two-plus decades to 2016, the HFRI Equity Hedge Index beat the S&P 500 Index, and did so with 40% less volatility, as seen in the chart below. It also trounced the Bloomberg Barclays U.S. Universal Aggregate Index (U.S. Universal Index).
Outperformance Over Market Cycles
Source: Goldman Sachs, Morningstar.
The chart shows that long/short equity strategies have worked best over full market cycles. But one of their most valuable features is the potential to offer differentiated returns from those of core asset classes during market swoons. And in the case of liquid alternative long/short equity funds—which allow redemption of mutual fund shares on a daily basis, unlike their private hedge fund cousins—cashing in on returns in up or down markets is easy and efficient.
Ideally, though, investment portfolios should preserve capital during downturns, and grow it via compounding into the future. In the short-run, the performance of any asset class may contribute to—or detract from—overall portfolio returns. As they are designed to mitigate the effects of severe drawdowns, long/short equity funds can, like bonds, increase portfolio diversification, lower correlation and so reduce overall portfolio risk. This is perhaps their biggest advantage for investors in both the short and long terms.
Before investing, carefully consider the Fund’s investment goals, risks, charges, and expenses. For a prospectus or summary prospectus containing this and other information, contact your financial advisor or visit our literature center. Read them carefully before investing.
The performance data quoted represents past performance; it does not guarantee future results.
The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This information should not be relied upon as a recommendation or investment advice and is not intended to predict the performance of any investment or market.
Investments carry risks, including possible loss of principal.
Any securities, sectors, or countries mentioned are for illustration purposes only. Holdings are subject to change. Under no circumstances does the information contained within represent a recommendation to buy or sell any security.
Investments carry risks, including possible loss of principal. Additional risks may be associated with investments outside the United States, especially in emerging markets, including currency fluctuations, illiquidity, volatility, and political and economic risks. Investments in small- and mid-capitalization companies may increase the risk of greater price fluctuations. A short position will lose value as the security's price increases. Theoretically, the loss on a short sale can be unlimited. Investments in derivatives are subject to the risks associated with the securities or other assets underlying the pool of securities, including illiquidity and difficulty in valuation. Non-diversified funds can be more volatile than diversified funds. Investments in the Fund are not FDIC insured, nor are they bank deposits or guaranteed by a bank or any other entity.
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