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In the volatile markets of early 2014, it has become far more challenging. This year will be about generating alpha, while keeping beta in check.
By mid-January the markets were already roiling on concerns over emerging markets and their currencies, China and the potential fallout of their shadow banking system, and the disposition of quantitative-easing (QE) tapering after the next Federal Open Market Committee (FOMC) meeting. On Jan. 24, the Dow Jones Industrial Average sank 318 points, and the stock market registered its worst weekly drop in more than two years.
Short-term traders can thrive in these markets, trading volatility throughout the day, buying the VIX, and utilizing other short-term strategies to hedge risk and generate profits. Longer-term investors need other strategies to survive these markets. …
…A defensive approach to volatile markets we particularly like is a long/short strategy. A combination of long and short stock positions in your portfolio can mitigate or virtually cancel out market risk. Achieving a near “market neutral” portfolio can be a meaningful step in reducing risk. …
…Obviously, there is a great deal of work and research in picking the individual names. Another approach is to utilize an investment vehicle that accomplishes this with a strategy or manager that has demonstrated success.
One such vehicle we favor in the current market environment is PIMCO EqS Long/Short Fund. This fund has the enviable track record of outperforming the S&P 500 Index in last year’s roaring bull market with significantly less risk than that index, and also declining far less than the S&P 500 in the last bear market. …
…There are also “130/30” long/short funds to consider. The 130/30 strategy uses financial leverage by shorting poor-performing stocks and going long stocks that are expected to have high returns. A 130/30 ratio implies shorting stocks up to 30% of the portfolio value and then using short-sale proceeds to take a long position in the stocks the manager feels will outperform the market. …
…Some long/short funds will concentrate on a single industry. Paring long and short positions among stocks in the same industry can significantly reduce industry-specific risk along with market risk. Because stocks of the same industry tend to move in similar cycles, being long one stock and short another tends to cancel the volatility of each position against one another.
Through a long/short strategy, a manager can capture growth in a particular industry sector, but with lower volatility and more consistency than long-only investing. Short positions can take advantage of weaker companies and outdated business models in the space. …
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