EC HH The Lowdown On Long-Short ETFs

EMAIL INBOX: Dave – read your article today.What is your take on the long-short ETF space at this point in the market?Products like DYLS and DYB are looking more appealing in my opinion.Interested to hear your take.

The long/short ETF category is one that many investors may not even know exists. These strategies have typically been the realm of institutional portfolios and sophisticated hedge funds. Now, they are readily available in the form of a diversified and liquid investment vehicle. 

Long/short funds should be considered “absolute return” strategies because they seek to mitigate downside risk when the market takes a turn lower. They generally contain some sort of hedge in the form of short positions in individual stocks, futures contracts, or stock indexes. They may also use a volatility-linked channel such as the CBOE VIX Volatility Index as a form of risk management when paired with a long-only index such as the S&P 500.

Some are consistently long and short at the same time. Others may seek a more sophisticated method of using rules to turn the hedge (short) on or off when needed. This would theoretically reduce the performance drag in up markets and dampen price volatility in down markets. Nevertheless, there are many pros and cons of each that must be considered before implementing these funds in your own accounts.

Evaluating The Field

One of the largest in this space is the First Trust Long/Short Equity ETF (FTLS), which has $111 million dedicated to a balance of long and short equities. FTLS is an actively managed fund that gives the portfolio manager leeway to select an allocation of 80%-100% long stocks and 0%-50% short positions.

Most of the FTLS holdings are individual stocks, with more than 200 positions currently established. The fund fact sheet touts both fundamental and quantitative reasons for selecting the individual positions in the portfolio. The best case is for the fund manager to be long stocks that outperform and short stocks going in the opposite direction. That sounds a lot easier than it probably is to execute.

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Michael Stevenson 2 years ago Member's comment

David, the technology is evolving quickly, in the future you will see hedges which move away from a binary on/off switch to a dimmer switch capable of mitigating the risk in smaller increments. Even further advances will not only mitigate Market Risk but will also mitigate specific sector risk as the sector becomes overvalued or out of favor, and they will do it simultaneously. http://www.alphavee.com Sector Risk Article