The amount invested in Zenith-rated long-short Australian equity strategies surged 43% in the 12 months to March as investors steer portfolios through a prolonged bull run with concerns for a market correction in the future.
Over a four-year period, Zenith has seen a 78% growth in funds invested in the segment.
Managers running long-short strategies include L1 Capital, Perpetual, Grant Samuel, Ausbil, Wavestone, Bennelong, Solaris, K2, PM Capital and Blackrock among others.
Zenith Investment analyst Jacob Smart said: "The results of our analysis provide clear evidence of the beneficial role that long-short strategies can potentially play in an investor's portfolio. It is also important to recognise that short selling is a specialised skill set that we assess carefully when rating funds. The ability to short sell effectively is a key determinant of success in the overall strategy."
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Zenith currently rates 18 long-short strategies. Seven were screened out and not rated.
The best performer was the Regal Australian Small Companies Fund which produced 42.4% in the year to April 2018.
Long-short equity funds invest in shares just like long-only equity funds. However, they are also equipped with the ability to "short sell" stocks. Short selling allows investors to profit when stocks or markets decline - hence the appeal to investors in times of market uncertainty.
The cohort as a total returned 11.7% p.a. in the five years to March. This was 4.1% higher than S&P/ASX 300 Accumulation Index return of 7.6% p.a.
Risk volatility was also lower for long-short funds, with annualised standard deviation of 8.9% versus 11.2% for the index.
They also capture the market's upside and downside risks effectively, Zenith said. In the five years to March 2018, long-short funds captured 92% of the market's upside return, which is within close range of the 98% upside capture for long-only funds, the researcher said.
When markets fell, long-short funds provided a much higher degree of downside protection, suffering only 57% of the market's decline, compared to 86% for long-only funds.
Zenith calculated that a $1 billion FUM was the optimal size positioning for long-short fund's shorting component.
This is mainly because short selling requires stock borrow, which has limited supply. This supply shortage is reflected in the low volume of short sold stocks, with only 2% of the Australian equity market held as short sold as at 31 March 2018, Zenith said.
"Our hypothetical capacity target provides a line of sight to guide optimal short selling effectiveness. Pleasingly, all our rated managers have leverage-adjusted short exposures that are below this figure, providing our financial adviser clients with confidence that capacity among our rated funds is prudently managed," Smart said.