Long-Short Equity is one of the largest alternative categories in terms of number of funds and total assets. Funds in this category invest primarily in equity (individual names, options, or ETFs), and can be further classified by geography (currently only in Morningstar's hedge fund categories). These funds generally exhibit betas to domestic or global equity indexes of between 0.3 and 0.8.
The standard long-short equity fund manager picks stocks long and short, with the goal of achieving returns through a combination of market risk and alpha from stock selection and market timing.
While many long-short equity managers employ shorts to generate returns, some also short to hedge out market risk, using index options, futures, or ETFs. Stock-picking managers may employ a top-down, macroeconomic approach to stock selection, while others may rely on a bottom-up process that focuses on individual company valuations.
Other variations of long-short equity strategies include managers who only pick stocks long, and who short only to dampen market risk (using index-based options, futures, or ETFs). Option-writing long-short equity strategies may not select stocks at all. The goal of option writing strategies is to collect option premium (often on an equity index), rather than to bet on the underlying stock. These strategies will generally hedge downside risk to a certain extent with put options.
Nontraditional Bond, one of the newest Morningstar categories, was designed to capture funds that invest primarily in debt instruments, but that cannot be entirely described by Morningstar's fixed-income style box. While long-only bond funds take on both duration (interest rate) and credit risk, nontraditional bond funds may hedge out one or both of these risks by shorting bonds or bond futures, or entering into interest rate or credit default swaps.
Some variations of nontraditional bond funds include domestic corporate bond long-short strategies, high-yield corporate or municipal long-short strategies, foreign sovereign debt strategies, and long-short U.S. Treasury bond strategies. Nontraditional bond funds will typically exhibit lower betas and correlations to traditional bond indexes (such as the Barclays U.S. Aggregate Bond Index) than long-only bond funds, and therefore serve to diversify a long-only bond portfolio.