Why Long-Short Funds Didn't Deliver

Jason Kephart: 2018 was a tough look for our guys running long-short equity funds. Long-short equity funds aim to deliver a smoother stream of returns than long-only equity funds and they should, in theory, help protect against big equity market drawdowns. Last year, that wasn't exactly the case. During the S&P 500's nearly 20% plunge in the fourth quarter, the average long-short equity fund lost around 11%, which is a decent showing. For the full year however, the average long-short equity fund lost 6.29%, while the S&P 500 only lost 4.83%.

Now we know we're breaking the taboo of comparing an alternative fund to the S&P 500, but when broad markets are losing money, liquid alternatives should be expected to lose less, just like they should be expected to gain less when broad markets are going up. A couple of the bigger funds in the category, like AQR and Boston Partners, were particularly stung by the poor performance of value stocks in the second quarter, and that put them in a hole before the market's big sell-off at the end of the year.

Going forward, investors need to be picky when choosing a long-short equity manager and understand any biases, like leaning into value, so they can properly set expectations for when a strategy should struggle and when it should excel. If value can break out of its big slump, we think AQR and Boston Partners should both have brighter days ahead.