A Long/Short Bridge Between Stocks and Bonds
Frothy stocks and well bid bonds can undercut portfolio performance if rates move higher, though long/short equity strategies can support long-run returns.
Can long/short alternative equity strategies work as a “bridge” between equity and fixed income? It’s an interesting question recently posed to us by a wealth advisory team. Both asset classes become vulnerable to higher interest rates when valuations are rich.
Historically, the answer is yes: long/short equity strategies have helped protect portfolios, particularly when the stock market became volatile or downward trending.
To be sure, that hasn’t been the case lately. Compared to “core” asset classes, hedge fund returns disappointed over the last three turbulent calendar years. The HFRI Equity Hedge Index returns ranged from a negative 1.0% to a positive 5.5% during the period. That contrasts sharply with the S&P 500 Index’s double-digit gains in 2014 and 2016, bookmarking a near flat 2015, amid high dispersion in U.S. fixed income returns.
But when viewed over a longer time horizon, the picture changes dramatically. Long/short equity strategies have outperformed, and with lower volatility. In the two-plus decades to 2016, the HFRI Equity Hedge Index beat the S&P 500 Index, and did so with 40% less volatility, as seen in the chart below. It also trounced the Bloomberg Barclays U.S. Universal Aggregate Index (U.S. Universal Index).