In this series of articles, we'll present the case for our Leonteq Alquant Long-Short US Equity ETP+ and explain how we came to launch such an investment product. In addition, we will also provide a comprehensive analysis of the Long/Short Equity space, examining its characteristics and key considerations for investors selecting Long/Short Equity vehicles.

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Why Long/Short Equity?

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The performance of any traditional stock portfolio consists of two key components: market exposure (“beta") and the investor’s active views (“alpha"). Typically, beta dominates performance. However, incorporating shorting into the strategy allows for offsetting market exposure and expressing both positive and negative views, offering two practical benefits:

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1. ‍Separation of passive and active for cost-effectiveness and simplicity. Passive Beta Investment to capture market returns at a very low cost. Long/Short allocation to independently manage active risk, enabling tactical adjustments without impacting the passive beta component.‍
2. Enhanced Diversification & Risk Management by maintaining a traditional long-only equity portfolio while adding a long/short allocation.

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Long/short strategies allow managers to express market views more effectively compared to constrained long-only portfolios, which must be much more concentrated to achieve a similar level of active risk.

Consequently, long/short strategies are likely to provide a more consistent source of excess returns. Over the past decade, a particularly challenging period for long-only U.S. managers, long/short managers have shown superior performance in generating excess returns (See Figure 1).

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Figure 1. Source: AQR Alternative Thinking 2023 Issue 4: Key Design Choices in Long/Short Equity, December 5, 2023 - Portfolio Solutions Group

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Why now?

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Stock markets rallied in 2023 and 2024 as inflation fell, but macroeconomic uncertainty remains high, and headwinds for equities are mounting.

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The past few decades delivered strong returns for stock/bond investors, but some of those gains were "borrowed from the future" through falling yields and rising valuations. Indeed, over the last 15 years the S&P 500 has delivered an annual growth rate of 16.7% compared to its long-term average of 8 - 9%. It would be very optimistic for an investor to think that in the next decade(s) the equity market will continue to deliver returns above the long-term historical average returns.

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Despite some correction in 2022, yield-based expected returns are still much lower than historical realized returns. Regardless of near-term monetary policy outcomes, interest rates are likely to be substantially higher for the rest of the 2020s than they were in the last 10-15 years. Higher cash rates generally mean smaller excess returns for equities and private assets.

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Bonds have become less reliable as diversifiers since inflation risks re-emerged in the 2020s. Inflation uncertainty may lead to simultaneous stock and bond losses, as seen in 2022. In this tougher investment environment, alternatives may play a crucial role.

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Private assets have seen significant demand and inflows, likely depressing their future returns. They also share similar economic exposures with traditional assets during prolonged challenging periods.

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Liquid alternatives, such as Long/Short Equity, use financial tools like shorting and leverage to hedge macro risks and deliver diversifying returns. These "cash-plus" strategies benefit directly from higher cash rates by holding free cash alongside active positions.

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Historically, they have delivered similar excess returns in both higher- and lower-rate environments as opposed to equity, private equity, and real estate (See Figure 2).

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Figure 2. Source: AQR: A Fresh Look at Multi-Strategy Alternatives January 26, 2024 - Portfolio Solutions Group

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To summarize, while traditional equity and bond exposures face mounting challenges, liquid alternatives offer a promising way to navigate the mid- to late-2020s investment landscape.

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Conclusion

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The arguments and current market dynamics described above lead us to conclude that the time was right to launch a Long/Short Equity vehicle. However, instead of launching another inaccessible, expensive, and intransparent Long/Short Equity Hedge Fund, we are innovating by providing the only exchange-traded Long/Short Equity product in Switzerland (and even Europe actually).

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Our ETP+ (Ticker: AQLS) on the Leonteq Alquant Long-Short US Equity Index (Index Ticker: ALTQUSLS) is traded on the SIX Swiss Exchange, fully collateralized, and accessible to all investors with no minimum investment requirement.

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Sources

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Part 1 is inspired by three interesting AQR insight research papers, namely: Key Design Choices in Long/Short Equity, Is Your Equity Hedge Fund Portfolio Resilient Enough for Uncertain Times?, A Fresh Look at Multi-Strategy Alternatives.

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Disclaimer

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‍This content is advertising material. This content as well as all information displayed on any of Alquant’s websites does not constitute investment advice or recommendation, and shall not be construed as a solicitation or an offer for sale or purchase of any products, to effect any transactions or to conclude any legal act of any kind whatsoever. Past performance is not a guide to future performance.

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