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The Long and Short of It

Morningstar's new category helps investors find hedge-fund-like strategies.

Dan McNeela, 03/06/2006

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This month, Morningstar rolls out five new fund categories to help investors better assess three fast-growing strategies. This article outlines our new long-short category. Look for our take on the new inflation-protected bond category and the new target-date retirement categories in the next few days.

Why We Created a Long-Short Category

In the past, we've placed long-short funds into either our moderate-allocation or conservative-allocation categories. That old framework made sense because the volatility of most long-short funds was comparable with those of funds that mix stocks and bonds in their portfolios.

That said, we were never entirely comfortable with having such different strategies residing in the same category. It was also difficult for investors to find long-short funds amid the large number of allocation funds, and the need for a new category became more apparent to us as the list of fund companies with long-short offerings grew in recent years.

Getting into the Category

First, a little background on what long-short funds are.

These funds typically buy stocks (or take "long" positions) just like other equity funds. In addition, they also short stocks or indexes with the expectation that these securities' prices will go down. Typically, funds that use shorting strategies borrow shares from a broker and sell those shares to another investor hoping that they can buy back the shares later at a lower price. Shorting stocks is associated with greater risk than buying stocks because short positions have the potential to lose more than 100%.

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