2019: A Good Year For 'Stealth' Long-Short Funds

The only way a long-short ETF can keep its volume and liquidity high or a traditional mutual fund can keep its assets high enough to pay research and operational expenses is to be on the right side of the market most of the time.

That may sound eminently logical and eminently obtainable but it is not. “A rising tide lifts all boats,” so a fund which, by its charter, must seek short positions even during a booming market (their logic being that there will always be laggards which they can identify) means that most of the time they under-perform in good markets.

By the same token, buying such funds in declining markets when they are still seeking the few good longs to offset their shorts will often leave you disappointed; when investors panic on high volatility down days or weeks or months, they sell into the tsunami no matter how highly they regarded their purchase just a few short months ago.

If you understand this, during and especially near the end of a fine multi-year bull market, you will often be the recipient of a tirade from someone who began investing, say, 7 or 8 years ago after reading some article or listening to a Wall Street analyst on television who advised them to simply buy an index fund and hold it forever since, “stocks always come back in the long run.”

That is true. But as John Maynard Keynes, economist and investor of yore responded to that sort of logic, “But this long run is a misleading guide to current affairs. In the long run we are all dead.” (By the way, recognizing the foibles of many of those in his own profession, the rest of that quote is, “Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again.”)

In my last article on long-short funds (“Is There A Long/Short Fund Worth Buying?”), I concluded that the by-charter seeking and buying of securities contra to the market would have left those funds bereft of the returns they sought, so they basically became long funds during the bull market. Take a look at almost any long-short ETF or traditional long-short fund over the past year and you will see that they rose almost in concert with the market – and dove just as hard in the 4th quarter decline.

That’s why I am following up now with these “stealth” alternatives to long-short funds. My alternatives, balanced funds and tactical allocation funds, have similar issues as the long-short funds but to a far lesser degree. The difference is that they don’t need to take the same level of risk. A balanced fund (ETF or traditional open-end), by definition, owns both stocks as well as fixed income assets. While they allow themselves the flexibility to change the mix, most start out with a 60% stocks, 40% bonds balance. If they are to truly hew to their charter and their promise to investors, as stocks become cheaper, the 60/40 discipline forces the fund to buy more shares when they are down and sell more shares as their ratio gets out of whack.

There is no magic here; just a discipline that makes the fund buy more of what is cheap and sell what is expensive. Some funds, which we think of as conservative-allocation funds, might plan to hold only 20-50% of their assets in stocks, while moderate-allocation funds might strive to hold 45-70% of their assets in stocks. Aggressive balanced funds might go even higher. I personally prefer the moderate allocation funds. I like owning some equities and I like even more a fund that buys more if they dip below certain holding levels.

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Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in LCORX, TWEIX, JANBX over the next 72 hours.

Do your due diligence. If I can help, you are welcome ...

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Bill Johnson 2 months ago Member's comment

Well done.

David Reynolds 4 months ago Member's comment

Nice!