Long-only versus long-short: which wins?

The long-only versus long-short argument has raged for many years, with long-short managers extolling their greater flexibility and long-only managers arguing that if the conviction isn’t there, they simply won’t bother holding the stock. Long-short managers wonder why, if their long-only counterparts have done the work and arrived at a negative view of a stock, they don’t try to monetise that view.

Put simply, long-only investing involves buying and holding securities with the expectation they will increase in value over time, while long-short investing takes a more dynamic approach by being able both to buy (going long) and sell (going short) securities, to profit from relative price movements.

More specifically, long-only strategies are typically used by investors who seek to capture broad market growth, relying on fundamental research to identify high-quality companies with strong long-term potential.

In contrast, long-short strategies aim to generate returns in both rising and falling markets by taking long positions in securities considered undervalued and short positions in ones throught to be overvalued, or which are already falling in price.

Long-short investing has historically been seen as attractive due to its potential to reduce market exposure and enhance risk-adjusted returns, particularly in volatile environments.

By capitalising on mispriced opportunities and managing downside risk, long-short strategies offer flexibility and diversification benefits that can complement a traditional long-only portfolio. However, they also require skilled managers with deep sector expertise and disciplined risk management to execute effectively.

Head-to-Head

Below are two Australian equity funds that have been randomly selected to go head-to-head in a comparison of their styles and approach. Note that for this exercise we have not considered their suitability for portfolios.

*Greencape Broadcap Fund may invest up to 10 per cent in stocks listed on any international stock exchange  

Investment Approach: How they compete

• Greencape Broadcap Fund: This fund employs an active, bottom-up stock-picking approach, building a diversified portfolio of 25 to 70 Australian companies across large-, mid- and small-cap sectors. The investment team tries to identify high-quality companies through rigorous fundamental analysis, aiming to achieve capital growth above the return of the S&P/ASX 300 Accumulation Index over the medium to long term.
• Regal Australian Long-Short Equity Fund: This fund uses a long-short investment strategy, taking both long and short positions in Australian listed equities. The approach is research-driven, employing bottom-up stock selection to identify mispriced securities. The fund may also use derivatives, such as index futures, to hedge portfolio risk and enhance returns, with the objective of outperforming the S&P/ASX 300 Accumulation Index, net of fees, over a rolling five-year period.

Performance showdown: Who leads?

Over one year, Regal led with a 21.81 per cent return, comfortably outperforming both Greencape (16.84 per cent) and the benchmark (15.09 per cent). However, across three and five years, Greencape and Regal posted similar returns, with Greencape ahead over five years at 9.01 per cent versus Regal’s 8.48 per cent.

On a ten-year horizon, both funds outperformed the index, with Regal at 10.42 per cent and Greencape at 10.24 per cent, versus the S&P/ASX 300’s 8.65 per cent annualised gain. This suggests that both strategies have delivered consistent long-term alpha, albeit through different styles – Greencape with fundamental stock selection and Regal with a long-short approach, benefiting in different market conditions.

Volatility and exposure

On the most commonly used measure of risk, volatility, Greencape Broadcap and Regal Long-Short have behaved in a similar manner, with Regal slightly higher (8.76% versus 8.78%). However, beta and r-squared reveal key differences in market exposure. Greencape Broadcap, with a beta of 1.00 and r-squared of 0.96, demonstrates a more correlated return profile to the general market. Regal Long Short’s beta of 0.81 and r-squared of 0.20 indicates significantly lower correlation with the market. The lower beta indicates reduced market risk, while the low r-squared measure reflects a strategy driven more by stock selection and short positioning than by overall market movements.

Gross exposure and Risk – which fits you?

The key distinction lies in gross exposure – long/short funds like Regal typically use leverage to amplify positions, running a gross exposure (long plus short positions) well above 100%. This allows them to hedge market risk or take advantage of relative mispricing between stocks. The lower beta and r-squared show that Regal’s strategy involves meaningful short exposure, reducing directional market risk while increasing idiosyncratic (stock-specific) risks.

Ultimately, Greencape behaves more like a traditional long-only equity fund, closely following the market (three-year correlation to S&P/ASX 300 = 0.97), while Regal’s long-short approach results in lower correlation and potentially greater divergence from index-driven returns (three- year correlation to S&P/ASX 300 = 0.78). This can be beneficial in times of market stress, where long-short funds may provide downside protection through short positions. Note, correlation does not imply causation and does not capture the entirety of the relationship.

While long-short strategies offer flexibility and hedging potential, long-only investing provides several advantages in terms of simplicity, transparency, and risk management. Long-only strategies, like Greencape, are easier to implement and manage, with fewer moving parts, and they are not exposed to the additional risks introduced from short-selling.

And the winner is…

Both long-only and long-short strategies offer unique advantages, catering to different investment approaches and market conditions. Regal Long-Short’s approach leverages both long and short positions to generate alpha, offering lower market correlation and potential downside protection. The flexibility to profit from mispriced securities, regardless of market direction, allows for a differentiated return profile.

In contrast, Greencape Broadcap’s long-only strategy provides a disciplined, high-conviction approach with strong alignment to fundamental stock selection, benefiting from long-term compounding and reduced complexity. Its high correlation with the benchmark ensures participation in broader market gains while avoiding the risks associated with short-selling.

Nick Hatzis