By Simon Constable
The stock-market volatility in the first half of 2020 should have been a near-perfect period for "long-short" mutual funds and exchange-traded funds to make a killing.
Unfortunately, less than one in three such funds made money for investors during this tumultuous period.
Long-short funds are those that allow portfolio managers to bet on securities they expect to rise in price, as well as those they expect to fall in price. They accomplish the latter through short selling, or selling borrowed stock in the hopes of repurchasing it at lower prices for a profit. Most traditional funds allow managers only to go long, or benefit from increasing prices.
"This seemed like it was a great environment for long-short strategies as we saw U.S. equities fall into a bear market and subsequently recover much of the losses," says Todd Rosenbluth, head of ETF and mutual-fund research at CFRA.
SPDR S&P 500 ETF (SPY), an exchange-traded fund that tracks the S&P 500 stock index, fell more than 30% from Feb. 19 through March 20, according to Yahoo. By the end of June, it was down only 8.4% as the market rebounded. (Neither figure includes dividends.)
Theoretically, long-short funds should have been able to profit from the initial drop in the market in late February and much of March by selling borrowed stock. The funds then had an opportunity to add to those gains by buying stocks ahead of the subsequent rally that started on March 23.
Yet, as Mr. Rosenbluth points out, the majority of funds in the category lost money, some substantially.
Only 30 of the 99 funds that fit into this so-called long-short category reported gains in the first half of the year, according to data from Morningstar.
ProShares Long Online/Short Stores ETF (CLIX) performed best over the 26 weeks, with total a return of 48%. The worst performer was Pzena Long/Short Value Fund (PZILX), which lost 28%.
Part of the problem for long-short fund managers was that the selloff and rebound occurred so rapidly. "Investors had to be great at timing the market to capture both sides of the trade," Mr. Rosenbluth says.
In addition, there typically are few restrictions on how the managers of long-short funds are allowed to invest money. "They are like a blank canvas," Mr. Rosenbluth says, which explains the wide dispersion of returns from the 99 funds in the group.
Making things more challenging for fund managers was a divergence in the performance of individual stocks that before the crisis were viewed as direct competitors, says Jack Ablin, chief investment officer and founding partner at the wealth management company Cresset Capital.
Netflix and Walt Disney, for example, "went into 2020 as head-to-head rivals in the entertainment business, and coronavirus drove a wedge between the two as the latter had to close its theme parks," Mr. Ablin says. Meanwhile, Netflix got a boost from streaming video from people stuck at home.
Put another way, Covid-19 in some ways changed the nature of the economy and hence the nature of stock picking. In turn that made it more challenging for fund managers to sort the winners from the losers
Overall, money flew out of the long-short sector, but one fund stood out, Neuberger Berman Long Short Fund (NLSIX), which attracted $824 million in new assets over the period.
Mr. Constable is a writer in Edinburgh, Scotland. He can be reached at firstname.lastname@example.org.