Long-short funds can be a safe investment option in uncertain times, suggest experts

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Retail investors have sprung up majorly to join their homeland institutional peers in a bid to heal the wounds inflicted by the unabated exodus of foreign institutions from the Indian equity markets.

Foreign institutional investors (FII) have pulled out close to Rs 2.83 lakh crore in the first half of 2022 itself, according to data from the markets regulator Securities and Exchange Board of India (Sebi). The markets, however, didn’t react in the likely manner, thanks to a whopping Rs 2.31 lakh crore pumped in by domestic institutional and retail investors during this period. Equity Mutual Funds had a share of Rs 1.18 lakh crore in the pie.

Retail participation in equities has surged not only from direct trading as record number of demat accounts were opened during pandemic, investors are also increasingly opting for the mutual funds route as well to make investments in equity. Apart from the normal equity and debt funds, there is another category that’s gaining ground these days. These are long-short funds.

So, what exactly are long-short funds? What is it that an investor can equate it to? Is it a substitute for a debt fund or a balanced equity fund or is it a new asset class which needs to be seen with different risk and return thought process? These were some of the questions that were discussed by Kamal Manocha, Founder and CEO, PMS AIF World, on a panel of three top AIF thought leaders at the PMS AIF World 3rd Mid-Year Summit held on July 8–9.

PMS AIF World is a new-age investment services platform focused on the space of alternates for those HNIs who are looking to do analytics and knowledge driven good investments.

Understanding Long-Short Funds

A long-short fund is a kind of mutual fund that has long positions in certain investments that it expects to go up while it goes short in investments which are expected to witness a decline. The fund invests in both the types of trade so as to maximise the returns.

According to Harsh Agarwal, Head, Tata Asset Management Ltd, in the Indian context, hedge funds are not a different asset class. “I think that, most of the hedge funds that have been coming up in India, are positioning themselves around different mutual fund categories”, he said.

So, according to Agarwal, whether it’s a debt fund, equity savings, balanced advantage fund or aggressive hybrids, there isn’t any long short fund in the country, which is as risky as Nifty. “There are some one or two notches lower risk”. They offer better risk management and downside protection.

Are long-short funds a good investment option?

Agarwal holds a positive view about this based on the whole analytics and data that is available for long-short funds. If we compare a debt fund to a long short debt oriented fund, the data shows that there is a very, very sizable alpha, between what mutual funds are doing, or what the investor can get in bank FDs, or even maybe, direct bonds. Looking at last one year’s performance, the two best debt oriented long short funds have given returns of about 14 percent, as compared to, say, five or six percent, in bank FDs. So there is a huge alpha over what a fixed income oriented fund could get.

Now, if we move towards equities, there are conservative hybrids, aggressive hydrates, and long short funds, which are positioned on similar volatility terms, downside risk, protection, and so on. “Even if you were to compare the long – short funds to these categories, let’s say equity, savings or both, we have long short funds which are tremendously outperforming these broad categories”, Agarwal added.

“In fact, the longest hedge fund in the country is beating Nifty, by four to five percent right from its inception, which was probably eight or nine years ago”. So there is sufficient evidence that there is a very strong merit in investing in these hedge funds.

When is the right time to invest in long-short funds?

According to Rajesh Bhatia, Managing Director & CIO, Investment Trust of India, in the events of sharp draw-downs of the past, especially that of 2008, which was the worst year for Indian equity markets, with markets falling about 55 percent, “you realize the value add of protecting downside and the virtue of protecting downside risk, one of the main principles of long-short funds, is extremely important”. He believes that, given the environment that we’re walking into, which is macro driven, fragile environment, the need for a risk adjusted strategy could have never been greater and long-short funds provide the right investment option in the current scenario.

Outlook for the markets

For the last nine months, everybody has seen the pain in the markets. So what lies ahead in the coming months?

According to Vaibhav Sanghavi, Co-CEO, Avendus Capital Public Markets Alternate Strategies LLP, the one major reason for all the pain in global equity markets is inflation, which to a large extent is because of oil. “We do think that inflation has clearly peaked out and, I think it will probably change from September onwards”.

The commodity prices are seen correcting by about 25 – 30 percent and oil is just a matter of time when growth forecasts for global economies are aggressively brought down.

“We do think that the oil prices cannot sustain those kind of higher levels, so we clearly believe that inflation is peaked out, and the kind of hawkish central banks, which are there globally, will just pull out of their hawkishness, probably in a few months, maybe a quarter or two maximum”.

However, Sanghavi cautioned that the coming quarter can be extremely tricky and choppy and one must not make any mistake about it. “Post that I think we should be in a very, very good time, at least for the couple of years, in the light, that earnings are going to be strong and FPI would come with a bang”.

Bhatia also believes that the one variable one must closely watch is the oil price. “Fortunately, if oil falls to $60/barrel, great, I think that’s going to be a phenomenal construct for India, interest rates will not go up for India, as much as they will have to for the developed world and we will start an economic up-cycle in India, which is going to be very, very healthy”.

Like Sanghavi, Bhatia is also equally bullish on India over the next three to five years. “But I think in the shorter term, where oil goes matter a lot and if oil goes to $150/barrel, it will seriously impact on macros, balance of payments, fiscal deficit and monetary policy flexibility”.

Disclaimer: The views and investment tips of investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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