Long-Short
The hottest hedge fund strategy in the world right now is a Long-Short equity approach popularized by AQR Capital Management (AQR) which has managed to vacuum up some $100B+ in assets under management.
The Long-Short strategy is seductively simple, and when executed correctly, can validate the fees being charged. Simply put, a Long-Short strategy seeks overall total portfolio growth. How it accomplishes this though is very interesting.
Investors, predominantly higher-net-worth and/or those with concentrated stock positions, either deploy capital in the form of new cash or inject existing equity positions into the strategy. To fully benefit from a Long-Short equity strategy assets are typically non-qualified (read as non-IRA, 401k, Roth, etc.) Typically these are assets are subject to the standard tax code.
Using a Long-Short strategy a Portfolio Manager is simultaneously LONG (ie owning the position outright) and SHORT (selling a position he does NOT own.) This can be confusing. Most people understand the LONG leg of the strategy. It means you are betting on the future appreciation of a stock for example. A SHORT position is just the opposite; you are betting on the future DEPRECIATION of a stock.
For better or worse, modern finance has "evolved" via the use of derivatives to allow for short selling and also purchasing of options contracts like CALLS and PUTS which give the buyer the OPTION (but not the requirement) to either BUY or SELL a stock. Additionally, this strategy also uses one of the three "Ls" railed against by Charlie Munger: Leverage.
By combining several traditional investing methods with several modern financial tools portfolio managers can successfully produce BOTH absolute alpha (growth) in a portfolio AND throw off LOSSES which can be harvested to off-set gains elsewhere. Tax rates can effectively be reduced to zero.
We can thank "an erudite dandy" who drank scotch with Hemingway in his youth while overlooking the Spanish Civil War for the origin of this strategy.
Jones published a finding of his research in the March 1949 issue of Fortune magazine titled "Fashions in Forecasting." While not a Harvard MBA, this magazine can be purchased on eBay for $20. Like most "fringe ideas" it was only initially noticed by the very observant looking for an edge wanting to break into the financial world.
Warren Buffett took notice. In 1956 Buffett started Buffett Associates with $105,000 and a 50% (you read that correctly) management fee on any return GREATER than 4%. A classic Balzacian outcome ensued, ie: "The secret of a great fortune for which you can find no cause is a clean crime, because it was cleanly done."
Carol Loomis reported on Jones's results on April 1st, 1966, some 17 years after Jones had launched A. W. Jones & Company, in her seminal article in Fortune magazine titled: "The Jones Nobody Keeps up With"
This article sparked further imitation by nascent wealth managers including George Soros and his Quantum Fund as well as Michael Steinhardt's Steinhardt Partners. Soon hedge funds became the preferred investment vehicle of limited partnerships.
The Limited Partners (LP) strategy to investing got so hot in fact, Buffett closed down Buffett Partnership Ltd. at the end of 1969. He told his partners something to the effect that there was little future opportunity in a company he had just purchased called Berkshire Hathaway. Why deal with pesky limited partners?
Fast forward some 50 years and AQR founder Cliff Asness, along with a host of other firms, are raking in serious assets by offering a classic Long-Short hedge fund strategy...with a twist: A big selling point is that the 2.0 version STRATEGICALLY THROWS OFF LOSSES.
Why in the world would savvy investors want LOSSES? ILAF readers know we are all about growth. Why would sophisticated, wealthy, and smart investors want to LOSE money? Ahhh...read on dear farmers...as they say "timing is everything."
To a rich man losses are as valuable, if not more, than taxable gains. Indeed, the best time to take a gain may be never. The reason for this is the way the tax code is structured. Although a Long-Short strategy's OVERALL goal may be to pursue growth, it has a very, very interesting feature of throwing off significant losses.
These losses can be harvested just like ripe fruit my dear fellow farmers. Succulent, aromatic, peach juice dripping down your elbow oh delicious losses! And like any good harvest, you can can those peaches baby! Losses can be carried over from year-to-year-to-year.
Think of it like this: You have a farm with dozens of crops. Every year many of those crops grow and do extremely well. Some, however, fail. The current tax code allows you to harvest that loss, and keep it on your books INDEFINITELY.
Sooner or later you *might* need to take a gain, for whatever reason; ie you are in need of a 2nd, 3rd, 4th home or your G550 needs engine work. Fear not. That carried loss can now be applied to your large gain.
As Apple, Facebook, Google, OpenAI, Anthropic, Microsoft, Amazon, SpaceX, etc. engineers occasionally leave their offices Wealth Managers are waiting for them in the parking lots ready to offer them this fantastic opportunity. Investors? Could be you!
This Long-Short 2.0 strategy has been increasingly proactive in the crystallization of the "K-shaped" economy where the (financial) winners are predominantly young(er) engineers or employees with significant equity stakes AND Baby Boomers at the highest echelons with considerable net worth.
Consider, there are almost a MILLION Americans with OVER $10M. Over 100,000 have $50M+. And some 10,000 have over $100M. A lot, probably 80-95%, of that wealth is in UNREALIZED gains that will not be taxed until it is realized. Even in death there is a significant tax break in terms of the cost basis being RESET to fair market value.
So if you're a financial farmer plowing the fields, earning a good living, and saving for the future it behooves you to consider allocating a good portion of your liquid net worth to a Long-Short equity approach. Just make sure it is tailored to your specific needs, risk tolerance, and time horizon.
