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Investment strategy
April 19, 2021
5 mins

The long and the short of unstoppable trends

April 19, 2021
5 mins
Daniel O’Donnell
Global Head of Citi Investment Management Alternatives
Michael Stein
Senior Portfolio Manager, Hedge Fund Research & Management
Michael Yannell
Strategy Head, Hedge Fund Research & Management
Woman on phone walking on street
SUMMARY

Certain specialist hedge funds strategies seek to exploit performance differences between the winners and losers of unstoppable trends.


Powerful long-term forces are revolutionizing the ways we live and do business globally. These include digitization, increasing human longevity and the continued shift of economic power towards Asia. We call these forces “unstoppable trends.”  And we believe that they can endure throughout economic cycles, offering resilient growth potential to investors who harness them in portfolios.

For qualified investors, long-short hedge fund strategies may offer a relevant way to gain exposure to unstoppable trends. Such strategies seek to benefit from the difference in performance between related equities. The idea is to add exposure to the potential winners of a certain unstoppable trend, while simultaneously short selling potential losers of the same trend. If the potential winners indeed outperform the potential losers, the long-short strategy generates positive returns. Importantly, the strategy may deliver positive returns even when the broad equity market is declining, provided that the long positions decline by less than the short positions.

Of course, the outcome of this strategy depends significantly on the skill of the long-short hedge fund manager. Specifically, the manager needs to be able to select the appropriate companies in which to establish long and short positions. If the manager’s assessment of likely winners and losers of an unstoppable trend is incorrect or premature, the strategy could see short positions outperform the long positions, leading to outright losses. 

Over the last decade, long-short strategies overall have been unable to keep pace with the bull market in equities.  However, some specialists have managed to achieve stronger performance. For example, long-short strategies focusing on the healthcare and technology sectors have produced both higher absolute and risk-adjusted returns.

One reason for this is the wide difference in returns between the strongest and weakest equities in these sectors. Such dispersion creates more potential opportunities for managers to apply their selection skills.

Figure 1 shows performance statistics of the HFRI Equity (Total) Index, the HFRI EH: Sector – Technology/Healthcare Index, and the MSCI World Index for the ten years ending December 2020.

 
Figure 1
Chart showing performance statistics of the HFRI Equity, Technology/Healthcare And MSCI World index.
HFRI and Bloomberg. The HFRI Equity Hedge (Total) Index tracks strategies that invest in both long and short positions primarily in primarily equity and equity derivative securities. The HFRI EH: Sector - Technology/Healthcare Index tracks strategies that specialize in technology, biotechnology and as related to production of pharmaceuticals and healthcare industry. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.
 

We believe that such opportunities for specialists to outperform will likely persist over the coming years. Here are some of the areas that we believe are ripe for long/short managers to apply their skills.

Digitization

The pandemic has accelerated long-term digital developments that we have been highlighting for some time. COVID has produced a marked shift towards remote working, e-commerce, and online health and wellness. We see an ongoing investment opportunity across digital infrastructure and technology assets, as capacity remains insufficient to meet future demands of an increasingly connected world and the accelerating growth in mobile data and video consumption.

We continue to pursue investment strategies that seek to take advantage of these digital demand drivers. Conversely, companies whose technology is on the wrong side of innovation or that will not achieve expected growth rates make for desirable short candidates.

Increasing longevity

More people are living to a greater age than ever before. This unstoppable trend of increased human longevity has been a key driver in healthcare innovation and spending. While COVID has clearly caused acute economic stress in certain sectors, the secular demand growth for health care is largely unchanged.

We believe there will be increased opportunities for companies that address unmet clinical needs and improve the quality/cost dynamic. Growth strategies focused on companies that have achieved proof of concept, concentrating on commercializing and scaling products or services with proven unmet needs and market viability, are an area of focus.

The biotechnology sector contains a wide range of companies focused on drug discovery and development, which warrant the pursuit of additional opportunities in 2021. However, drug development programs have a high degree of failure and many not be effectively monetized, creating opportunities for short selling.

The rise of Asia

As Asia’s contribution to global economic output increases further, we continue to focus on attractive investment opportunities in Greater China. The region’s demographic tailwinds remain robust. To capitalize upon this in tandem with the digitization trend, we are reviewing strategies for consumer-focused, technology-enabled businesses that benefit from the growing Chinese middle class and the adoption of next generation technologies. At the same time, the shifting growth trends and inefficiencies in areas such as corporate governance create dispersion in returns. Such dispersion may create scope for investing both long and short.

As the world economy recovers from COVID in 2021 and beyond, we recommend that qualified investors consider exposure to long-short equity strategies. As unstoppable trends continue to assert themselves over time, the potential for their beneficiaries to outperform victims could intensify.

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