Page 19 - Investment Advisor - October 2021

ALTERNATIVE INVESTMENTS

By Josh Vail

The Great Value Rotation: Are Your

Clients Prepared?

Factor-based long/short equity strategies can help take advantage

of the market’s changing slant.

fter a long run for growth value divergence, providing the poten-
stocks, value has shown some tial to increase expected return without
A signs of coming back into favor pure beta exposure (or at least con-
in 2021, and many investors wonder trolled beta exposure). The investor’s
whether it may represent a changing of active risk bet is more concentrated on
the guard among investment styles. the dynamic between value and growth.
Those in the value camp note sev- Long/short equity funds offer
eral trends that could favor the stocks another benefit relative to an active
going forward, including an ongoing or passive value strategy: Lower mar-
economic recovery and continued signs ket correlation. The long/short equity
of inflation. The latter could lead to a fund’s ability to take both long and
rise in interest rates, which penalizes short positions has historically helped
the valuations of growth stocks more such strategies perform well when mar-
than value. kets are down because the gains from
From a valuation standpoint, value the high correlation means the value- the short positions can offset the losses
benchmarks are also more attractive tilted portfolio will still bear much of in long positions.
relative to their historical averages than the market’s returns, even if it outper- In summary, the long/short equity
growth indices. Perhaps more simply, forms growth. fund could offer the investor protection
many believe that after growth stocks A different way to invest behind from the broader market, while at the
outshined value for more than a decade, the trend is through long/short equity same time maximizing the gains from a
maybe it’s time that value had its day. funds, or other alternative strategies divergence in growth and value.
Whatever the reason, if advisors that use factors as the basis for deter- There are, of course, still key ques-
and their clients believe value is set mining which stocks to short. tions advisors must consider about a
for a longer run, a key question is: How long/short equity fund. Advisors will
best to invest in the trend? It may not ISOLATING THE DIVERGENCE have to perform necessary due diligence
be as simple as making a modest asset For advisors who believe value is poised on a manager’s investment process. That
allocation shift toward value strate- to outperform growth and want to invest includes questions about how they select
gies. The reason: Most value strate- behind the change, long/short equity what factors to short or invest long, and
gies still have a high correlation to funds may provide a better option to how a manager dynamically adjusts fac-
the broader market. For example, the isolate that view. tor positioning. For example, if the value
Russell 1000 Value Index has a cor- Many long/short equity funds decide factor enjoys relative outperformance
relation of 0.95 and a beta of 1.00 to what stocks to short or invest long based over a long window, how and when
Russell 1000 Index. on what factors they believe are likely would the fund change positioning?
That means an investor who piv- to out- or underperform. A straight- But advisors interested in investing
ots toward value strategies will not forward example of how using a long/ behind a growth to value rotation —
see much difference in their portfolio short equity portfolio could put more or other rotations favoring new factors
returns than had they kept their origi- emphasis on the value exposure would — should give factor-based long/short
nal allocation or simply invested in a be to imagine a portfolio that is long the equity strategies a closer look.
Adobe Stock fall — a concern for some investors This type of strategy would essentially Josh Vail, CAIA, is managing director of
value factor and short growth stocks.
core equity strategy. And if markets
capture both sides of the growth and
given where valuations sit today —
Hamilton Lane.

OCTOBER 2021 INVESTMENT ADVISOR 17