As equity markets trade near record highs and valuations exceed historical averages, the investing environment appears to us ripe for new sources of returns. In this environment, long/short equity strategies may be well positioned to pick winners and avoid losers - potentially an attractive proposition for investors who seek diversified sources of return.
• Equity long/short strategies can reshape the risks of equity exposure by going "long" stocks with favorable fundamentals, while selling "short" those with less favorable characteristics
• In the effort to adapt portfolios after years of rising equities, we believe investors should consider strategies which seek to deliver attractive risk-adjusted returns both when markets are rising and when they are falling
• Long/short equity managers tend to find more opportunities when single stock correlations are low or declining
• Long/short equity strategies can play a diversification role in an investment portfolio
EXHIBIT 1: DECLINE IN SINGLE STOCK CORRELATIONS PROVIDES MORE OPPORTUNITIES FOR STOCK PICKING AND ALPHA GENERATION
S&P 500 single stock correlations have been declining
Source: Source: Goldman Sachs Global Investment Research as of 12/31/2014. S&P 500 single stock correlations measured the average realized correlations between all of the underlying names in the S&P 500 index over 3 months, 6 months, and 12 months. Past performance does not guarantee future results, which may vary.
The Case for Long/Short Equity Investing
Where have investors found growth? The answer, for the past several years, has been the equity market. Since 2013, the S&P 500 has hit a series of record highs, with a similar trend in Europe, where the pan-European Stoxx 600 index hit fresh record highs in April 20151. Several country-specific indices have also left the financial crisis in the dust.
At the same time, investors have not experienced a large market correction in years. Today, there is increasing uncertainty surrounding the timing of the Federal Reserve's first interest rate increase. Risks such as the question of Greece's solvency may also warrant investor attention in the short run.
As valuations continue to rise, investors may question whether recent years' trend of rapid price appreciation can last. Diversification of sources of risk and return can help improve the risk/return profile of their portfolio. For this reason, we believe investors should understand long/short equity strategies.
Finding the Right Manager
Many managers are launching products that can both take advantage of the growth in equity markets and also potentially mitigate losses. In Morningstar's UCITS Long/Short Equity2 categories, there are more than 350 funds, more than 40 of which were launched last year. This may make it difficult for investors to select the right manager.
Most importantly, we believe investors should consider a fund manager's skill, process and experience in selecting equities, both on the long and on the short side.
This is typically reflected in the fund manager's performance track record of managing an equity long/short strategy. Furthermore, we believe investors should consider whether UCITS fund managers have experience handling regulatory requirements, especially in providing liquidity to fund investors.
Conclusion
Although most individual investors only recently can access equity long/short strategies, institutional investors such as large pensions and endowments have been doing so for decades. Many institutional investors see equity long/short as a means of diversifying, by introducing another source of return to portfolios while potentially reducing the portfolio's overall risk - in terms of both day-to-day movements and during large equity market corrections.
Going forward, investors face the likelihood of lower returns in both bond and equity markets. In such an environment, we believe investors should consider adding equity long/short strategies to their investment portfolio.
Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur.
1. Source: Bloomberg; 2. Source: SimFund
Important Disclosures
This document has been issued by Goldman Sachs International, authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
General Disclosures
This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. This material has been prepared by GSAM and is not a product of Goldman Sachs Global Investment Research. The views and opinions expressed may differ from those of Goldman Sachs Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and GSAM has no obligation to provide any updates or changes.
Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. We have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources.
The portfolio risk management process includes an effort to monitor and manage risk, but does not imply low risk.
Economic and market forecasts presented herein reflect our judgment as of the date of this presentation and are subject to change without notice. These forecasts do not take into account the specific investment objectives, restrictions, tax and financial situation or other needs of any specific client. Actual data will vary and may not be reflected here. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. These forecasts are estimated, based on assumptions, and are subject to significant revision and may change materially as economic and market conditions change. Goldman Sachs has no obligation to provide updates or changes to these forecasts. Case studies and examples are for illustrative purposes only.
Confidentiality
No part of this material may, without GSAM's prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient. Goldman, Sachs & Co., member FINRA.
© 2015 Goldman Sachs. All rights reserved.
Compliance code 161980.STR.MED.OTU
