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Long/Short Strategy and Long/Short Funds Explained

A long/short strategy aims for returns independent of market direction, but that doesn't mean it's risk-free.

What a long/short strategy is

A long/short strategy buys (goes long) stocks expected to rise while short-selling stocks expected to fall, running both positions at the same time. It's a relative-return approach: it can profit as long as the long picks outperform the short picks, regardless of which way the overall market moves.

Why it targets market-neutral returns

By sizing the long and short books roughly equal in dollar terms, a manager can offset much of the market's overall up-and-down movement, aiming for returns driven mainly by stock selection rather than market direction. This approach is called 'market neutral,' and it's often viewed as more defensive than a typical long-only equity fund during sharp downturns.

Funds that offer this strategy

Long/short strategies were once mostly the domain of hedge funds, but many asset managers now offer them through mutual funds or exchange-listed products that ordinary investors can access. Regulatory limits on short-selling and leverage in these retail-accessible vehicles usually mean they can't fully replicate a hedge fund's more aggressive version of the strategy.

The risk sitting on the short side

The classic risk of a long/short strategy sits on the short side: if a shorted stock rises instead of falling, losses are theoretically unlimited, unlike a long position where the most you can lose is your initial investment. Add in stock-borrowing costs and trading costs on both legs, and the strategy tends to be more complex and more expensive to run than a plain long-only fund.

What to check when evaluating a fund

Rather than judging a long/short fund only by its past returns, check whether it actually limited losses during past market sell-offs, i.e. whether it behaved the way a market-neutral fund is supposed to. Fee structures, including any performance fee on top of the management fee, can vary widely between funds, so compare the fine print in each prospectus.

Why the short side changes the risk profile

In a long-only portfolio, the worst case for any position is losing 100% of what you put in. A short position flips that: if the price keeps climbing, the potential loss has no natural ceiling, since there's no limit to how high a stock can go. That asymmetry is why long/short managers spend as much effort on risk controls, such as position limits, stop-losses, and borrow-cost monitoring, as they do on picking stocks.

For general education only, not investment advice

This page explains the general mechanics of long/short investing and is provided for educational purposes only; it is not a recommendation to buy any specific fund or product. Availability, regulation, and fee structures for long/short funds vary a great deal by country and by broker, so review the current prospectus and disclosure documents before investing.

Frequently Asked Questions

Do long/short funds always make money in a falling market?

No. They're designed to target returns that don't depend on market direction, not to guarantee profit. If the manager's stock picks go wrong, a long/short fund can still lose money even while the overall market is falling. 'Market neutral' describes a goal, not a guaranteed outcome.

Can an individual investor run a long/short strategy alone?

In principle yes, but short-selling usually requires meeting margin and stock-borrowing requirements, and managing two offsetting positions at once takes real risk-management skill. For most individual investors, buying an existing long/short fund or ETF is a more practical way to get this kind of exposure.