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The Alter-NATIVE series How AIF fund managers generate alpha from short selling

How AIF fund managers generate alpha from short selling

AIFs regularly employ long/short strategies to capitalise upon opportunities on the short side.
Edelweiss Feature Oct 27, 2017

Investments are made under the implicit assumption that prices will move up over a period of time, thus generating returns. Fund managers as well as investors are constantly trying to generate alpha, which is basically returns in excess of benchmark returns. However, market and asset price movement is never unidirectional. Prices tend to be volatile, which necessitates investment managers to employ strategies that go beyond traditional long only investing. There is alpha to be generated on both the long side as well as the short side of a trade. Alternative Investment funds (AIFs) by their very definition eschew traditional investment styles in favour of varied asset classes and investment strategies.

Among others, AIFs regularly employ long/short strategies to capitalise upon opportunities on the short side. There might be instances that a company, lets call it ABC Ltd, is not doing very well due to bad management or just a difficult business environment. A fund manager looking to generate alpha may capitalise upon this situation in the following ways -

  1. He can either short sell the stock of the company or
  2. He can create a market neutral long-short strategy where he sells the stock of ABC Ltd and buys the stock of a similar, albeit more promising company, lets call it XYZ Ltd.

In both cases, the manager will make money if the value of ABC Ltd goes down. In case one, he is taking on higher risk and will most likely generate relatively higher returns. In the second case, a part of his risk exposure is mitigated by the long position in XYZ Ltd. However, this will most likely result in relatively lower returns.

Thus, investors who are looking to take advantage of varied investment strategies but don’t really have the know-how to implement them on their own can choose to invest in an appropriate AIF.

Past performance is not an indication of future performance. Investments in the securities market are subject to market risk.

Please read the Private Placement Memorandum carefully before investing.

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