An Introduction to Long/Short Equity Strategies
Many equity strategies are long-only: a manager buys stocks expected to rise and holds them, with portfolio exposure tracking the direction of the broader market. Long/short equity strategies take a different approach. Rather than expressing views only on what will rise, managers also take short positions in stocks they believe will fall—borrowing shares, selling them short, and aiming to buy them back at a lower price. The result is a strategy designed to generate returns from the spread between positions on both sides, seeking to reduce dependence on overall market direction.
As a hedge fund strategy, long/short equity is among the most widely used in the category, accounting for approximately $1.3 trillion in AUM, or about 29% of global hedge fund assets.1 For advisors exploring alternative investments beyond traditional long-only exposure, it may offer a framework for equity participation with the potential for reduced directional risk.
What Are Long/Short Equity Strategies?
Long/short equity strategy managers simultaneously hold long positions in stocks they expect to rise and short positions in stocks they expect to fall. Return comes primarily from the spread (i.e., the difference in performance between long and short positions).
A few terms define how these portfolios are positioned and measured:
Net Exposure: Long positions minus short positions, expressed as a percentage of capital; controls how much market direction drives outcomes
Gross Exposure: Long positions plus short positions, representing total capital invested, including leverage
Alpha: Return driven by the manager’s stock selection
Beta: Return driven by overall market movement
Most managers run a net long bias, meaning long positions outweigh short positions. Two structural realities often drive that tendency:
Equity markets have historically trended upward, so stripping out all market exposure risks giving up long-term tailwind.
Short selling is inherently more expensive and operationally complex than going long: borrowing fees, forced buyback risk, and the potential for short squeezes (which we explore later on) all make the short side harder to run.
That said, strategies exist on a spectrum (Exhibit 1)2.
Market neutral funds target roughly equal long and short exposure, meaning broad market movements affect both sides in roughly offsetting amounts, leaving the spread between long and short positions, driven by manager stock selections, a primary source of return.
Moderate net strategies maintain a partial net long position, meaning some market direction flows through the portfolio, but stock selection still drives a meaningful share of outcomes.
High net strategies carry exposure closer to a long-only portfolio, so market direction becomes the dominant outcome driver. In these strategies, short positions serve primarily as hedges against specific risks rather than a material source of alpha.
Net exposure can control how much of a portfolio’s return comes from market direction versus manager skill (Exhibit 1)
An example to explore this concept:3
Say a manager with $100 in capital puts $70 into a long position in Company A, a stock they believe will outperform, and $30 into a short position in Company B, which they expect to lag. Net exposure: 40%.
The market rises 10%. Company A climbs 14%, generating a $9.80 gain on the long side. Company B rises only 4%, costing $1.20 on the short. The portfolio is up $8.60, less than a long-only fund would have made (10%) because the short position is a drag in a rising market. That’s the cost of the hedge.
But the manager’s edge wasn’t about whether markets went up or down. Company A outperformed the market. Company B lagged it. The spread between those two picks, not the market direction, is what drove the return in this hypothetical.
That dynamic plays out across a range of structures. Advisors may access long/short equity strategies primarily through hedge funds structured as limited partnerships (LPs). ’40 Act funds and ETFs offering similar exposure also exist, with structural differences potentially including daily liquidity, lower minimums, and varying regulatory constraints, each of which advisors may want to evaluate when considering how they access a strategy.
How Do Long/Short Equity Strategies Work?
The investment process typically moves through three stages: generating ideas, building positions, and managing portfolio-level risk. Idea generation may draw on fundamental research (i.e., deep analysis of companies, balances sheets, and competitive dynamics), quantitative screening, or both. Position construction involves sizing longs and shorts relative to conviction and risk targets. Portfolio-level risk management covers exposure targets, factor and sector concentrations, and ongoing adjustments and market conditions evolve. Two dominant implementation styles have emerged:
Discretionary/Fundamental managers rely on bottom-up research and judgment to select individual securities. The approach depends on a manager’s ability to identify mispriced stocks through analysis that quantitative models may not capture.
Systematic/Quantitative managers use algorithms and factor models to drive security selection across large numbers of positions.
Some managers incorporate tax-aware strategies in their investment process, aiming to manage the timing and character of realized gains and losses that may result in more favorable after-tax outcomes for taxable allocators. Systematic managers are often particularly well-positioned to implement this at scale, given algorithms’ ability to screen and manage large numbers of positions continuously. These strategic approaches may also sit alongside other tax-aware strategies, particularly in real estate. Potential tax outcomes depend on current law and individual circumstances; advisors should consult qualified tax professionals.
There are also managers that deliver strategies through multi-manager or pod-based structures, where autonomous portfolio management teams operate with a centralized risk framework.
How Long/Short Equity Strategies Differ From Related Approaches
Advisors may encounter “long/short equity,” “equity market neutral,” and “long-only equity” used interchangeably or imprecisely. They’re different. (Exhibit 2)
For advisors, an important question is often how much market sensitivity is appropriate for a given allocation and how much of the expected return should come from manager skill versus market direction.
Potential Benefits of Long/Short Equity Strategies
Potential for Reduced Directional Risk: Short positions may partially offset losses during market declines, potentially improving downside capture relative to a fully long portfolio.
The Ability To Express Negative Views: Long/short equity lets managers act on negative convictions, not just positive ones. That two-sided capability is fundamental to the approach, and it’s something long-only strategies simply can’t replicate.
Flexible Risk Budgeting: Managers can adjust net exposure dynamically in response to changing market conditions, a degree of adaptability that may not be available in a fully invested, long-only vehicle.
Risks of Long/Short Equity Strategies
Long/short equity strategies carry risks that differ from, and in some cases may exceed, those of traditional long-only equity.
Short Selling Squeeze: Losses on short positions are theoretically unlimited. If a shorted stock rises sharply, particularly in a “short squeeze” where rising prices force short sellers to cover their positions and drive prices higher still, losses can compound quickly.
Leverage: Many long/short equity strategies use borrowing to magnify positions, which can increase the magnitude of both gains and losses and may amplify drawdowns in adverse conditions.
Manager Risk and Return Dispersion: Returns can vary widely across managers. Implementation style, exposure management, and stock selection may contribute to dispersion of outcomes within the category.
Fees and Expenses: Hedge fund fee structures typically include both management and performance fees. Some strategies also use pass-through expense models, in which certain fund expenses are allocated directly to LPs. These structures may reduce net outcomes.
Liquidity Constraints: Many long/short equity hedge funds offer monthly or quarterly liquidity windows with notice periods, potentially limiting the ability to exit quickly.
Complexity and Transparency: Systematic and quantitative strategies may involve proprietary investment processes that limit visibility into individual positions or decision-making. Advisors should understand what disclosures are available before allocating.
Idiosyncratic Risk: Company-specific factors such as management changes, earnings surprises, and regulatory actions unrelated to broader market movements may cause unexpected losses on individual long or short positions.
By expressing views on both sides of the market, these strategies aim to generate returns from stock selection while managing sensitivity to market direction. The spectrum runs wide: from market-neutral portfolios that seek to minimize beta to high-net-long strategies that use shorts primarily as hedges, giving advisors a range of options to consider.
