with Lower Volatility
The ability to engage in short-selling increases a portfolio manager’s opportunity to generate alpha from security selection. Without an ability to short, a negative view on a security can only be expressed by not holding that security, and the magnitude of the underweight relative to the index is limited to the security’s weight in the benchmark. For many securities, this weight amounts to mere basis points. The ability to short eliminates such constraints. By hedging out some market risk (beta), shorting also enables long/short funds to take bigger positions in their higher-conviction long ideas compared to more constrained long-only strategies.
Benefit from Diversification
Long/short equity strategies can provide an extra dimension of diversification to a long-only strategy. The diversification benefits stem from the ability of long/short strategies to offer returns with lower correlations to the stock market than long-only strategies do. Because long/short strategies don’t correlate perfectly with U.S. and global stocks, they can make good diversifiers in a portfolio, while dampening volatility.
Decrease Macroeconomic Risks
For many investors, equity market exposure represents an important expected driver of long-term capital appreciation. However, as we have experienced over the last several years, equity markets do not always deliver positive returns and may be characterized by periods of heightened volatility. We believe equity market volatility is likely to persist as the world today faces significant macroeconomic risks: high debt levels in Europe, a fiscal cliff and political polarization in the U.S., and slowing global growth. In the current environment of unusual uncertainty in the global economy and financial markets, extreme events are not only possible but they are probable. In an effort to guard against extreme macro events, PIMCO believes investors would be well served to choose strategies that seek to dampen downside risk.