Advisers choosing hedge-style stock-pickers face 'beta' challenge

Closet indexing, market timing are among the risks in long-short equity: analysts

Jul 8, 2015 @ 4:22 pm

By Trevor Hunnicutt

A letter in the Greek alphabet is key to understanding the core risks facing the most popular alternative-investing category in mutual funds: beta, according to two analysts who spoke on an InvestmentNews webcast.

The analysts pointed to two risks in mutual funds that can bet on both rising and falling stocks. The first is that the funds have largely failed in their attempts to time the market, according to Jason Kephart, an alternative investment strategies analyst at Morningstar Inc. The second risk is that managers sometimes charge plump fees while closely tracking the market, according to Dick Pfister, chief executive of AlphaCore Capital.

Beta is a way to measure both.

The category of mutual funds called long-short equity is the biggest winner in a push by advisers to sell more hedge-fund style strategies. On average, the funds returned -1.31% last month as volatility struck U.S. markets. That headline number compared favorably with the -1.94% of the benchmark S&P 500. For the year, they've delivered 0.64% to the S&P's 2.15%.

The numbers are not directly comparable because long-short funds typically choose to take on less risk than the market, a risk that's often measured by the statistical calculation called beta.

One problem is that some funds in the category are tracking the broad market very closely, said Mr. Pfister, whose financial advisory firm is a big proponent of alternative strategies. He recommends investors “peel back the onion” and look at signals, such as beta, to examine whether fund managers are effective.


“What you shouldn't expect is, when you're looking at a long-short equity mutual fund manager, their beta should not be in a tight range close to one,” Mr. Pfister said. A beta of one reflects a fund that responds very directly to market swings. “There's a lot of closet, long-only exposure in that fund.”

Mr. Pfister showed a chart, dated June 19, of about two dozen funds that take long positions, buying some stocks while shorting others, betting their price will fall. Four of the funds displayed appeared to mostly register a beta of one, when compared with the trajectory of the benchmark Russell 3000.

Mr. Kephart said a major challenge among managers in the long-short space has been dialing up and down their exposure to market risk at the right time.

“We've found that, over time, the amount of managers who can get those calls right consistently is basically zero,” Mr. Kephart said. “The ones that have been more successful have stayed in a range-bound beta exposure and delivered excess returns through their stock-picking skills.”

Long-short equity strategies, long deployed in hedge funds, have been the largest beneficiary of a surge in hedge-style strategies migrating to mutual funds. There is at least $56 billion in long-short equity strategies, in the U.S., according to Morningstar. But the category has struggled with outflows since last year, as performance fell off in the MainStay Marketfield Fund (MFADX), once the top-selling fund of its kind.


What do you think?

View comments

Recommended for you

Featured video


Female leaders highlighted as future of financial advice

InvestmentNews recognized 20 Women to Watch for their efforts to advance the financial advice industry.

Latest news & opinion

Blucora to buy another broker-dealer with tax-focused advisers

Blucora is paying $180 million in stock for 1st Global, with 850 advisers.

Finra panel dismisses $100 million case involving drop in Merrill Lynch stock

Former brokers bringing charges related to stock losses during financial crisis have had 15 cases proceed, four stopped so far.

Principal-Wells Fargo retirement deal would be among largest ever

Acquisition would be in line with trend of record keepers seeking to gain scale to combat fee reduction.

Finra panel dismisses $100 million case involving drop in Merrill Lynch stock

Former brokers bringing charges related to stock losses during financial crisis have had 15 cases proceed, 4 stopped so far.

ESG options scarce in 401(k) plans

There's growing interest among plan participants, but reluctance to add funds that take into account environmental, social and governance factors persists.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting It'll help us continue to serve you.

Yes, show me how to whitelist

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print