Mutual Funds That Short Stocks
Short selling a stock involves borrowing shares, selling them and then buying them back later (hopefully at a lower price) to return them to the lender. It's a bearish strategy: you are betting that a stock's price will decline so that you profit from the difference between the sale price and the subsequent purchase price. Few mutual funds employ short selling. Of these, there are three main strategies used, and each one attempts to lower risk by having simultaneous long (purchased) and short positions. These strategies seek returns featuring a low correlation to the overall market as measured by beta -- the amount of a stock's return explained by the returns of the overall market.
Other People Are Reading
-
Long/Short Funds
-
A long/short hedging strategy involves the selection of a long equity portfolio and then, in part, hedging it with short positions. The objective is to establish positions that provide upside gains while protecting against downside losses. The short positions can be composed of short stock and/or derivative positions in options and futures that benefit from price declines. Most fund managers utilizing a long/short hedging strategy favor a directional long bias -- their long positions are not completely hedged. An example is the Bull Path Capital Long Short Fund. Its returns are not closely correlated with those of the overall market due to the hedging effects of short positions. In 2010, its beta was a low 0.31. By definition, the overall market has a beta of one.
Equity-Hedged Market Neutral Funds
-
Equity-Hedged Market Neutral, or EHMN, funds seek to separate overall market movements from fund returns. The fund takes positions in pairs of related companies, buying the one perceived to be undervalued and shorting the overvalued one. In effect, the fund manager is entering a wager on the eventual outperformance of the long position. By investing equal dollar amounts on each member of the trading couple, these funds attempt to achieve an overall neutral long/short position. These funds are trying to eliminate beta as a factor in fund performance. The Vanguard Market Neutral Fund Investor Shares are typical example -- it advertises itself as, "appropriate for a small portion of an already well-diversified portfolio."
-
Enhanced Active Mutual Funds
-
Intermediate between long/short equity hedging and equity hedged market neutral is a fairly new strategy, known as an enhanced active, or 100X--X, fund. This kind of fund has the following features:
-- It maintains short positions equal to some percentage of the total assets ("X", generally 20 percent or 30 percent but possibly more) and an equal percentage (100 + X) of long positions. For instance, a 120-20 fund would short an amount equal to 20 percent of its assets under management, and use the proceeds to purchase an additional 20 percent of its long position.
--The fund borrows securities from prime brokers using special procedures so that it doesn't have to put up margin (collateral) when purchasing the additional 20 percent long position.
--It uses quantitative techniques to actively adjust the timing, selection, and hedging ratios of its holdings.
An example is the Fidelity 130/30 Large Cap Fund, normally targeting long positions of 130 percent of its net book, and short positions equaling 30 percent of its net book.
Exchange-Traded Funds
-
An Exchange-Traded Fund is a basket of stocks that trades as a single stock on an exchange. These securities are a popular alternative to mutual funds. They offer one key feature that most mutual funds lack -- traders can short ETF shares even if the ETF itself doesn't engage in shorting. Thus, investors can short an investment vehicle that substitutes quite well for a mutual fund.
-
