Long, short and neutral

So far, we have talked about what to buy. Here, we talk about how to set up the bet. Because you can also gain when things fall.

In nineteen forty-nine, an American journalist, Alfred Winslow Jones, created a new kind of fund. It is seen as the first hedge fund.

His idea: own the shares he likes, and sell short the ones he does not. That is called long short.

Selling short means borrowing a share, selling it right away, and buying it back later. You gain if it has fallen meanwhile.

Say one hundred thousand euros bought in a solid company, and one hundred thousand sold short in its fragile competitor.

The market drops. The solid one loses five per cent: minus five thousand euros. The fragile one loses fifteen per cent: plus fifteen thousand for the seller.

Result: ten thousand euros gained in a falling market. What counts is no longer the market, but the gap between the two.

But careful: a share sold short can rise without limit. The loss has no ceiling.

The market-neutral fund takes the idea all the way. It balances its bets so the market, on its own, neither earns nor costs it anything.

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What the market brings is called beta. What the manager adds through talent is called alpha.

Market neutral removes beta to keep only alpha. On paper, it is a return that depends on no crisis.

In practice, alpha is small, and everything starts moving together in panics. Neutral is often less neutral than advertised.

Another family, global macro. Here, you do not pick companies: you bet on countries, currencies, interest rates.

Will a central bank cut its rates? Is a currency too dear? The macro manager plays his answer, with large amounts.

George Soros's bet against the pound sterling, in nineteen ninety-two, remains the most famous example of this style.

Last family, event driven: betting on a specific event in a company's life.

An announced merger, which may fail. A bankruptcy, where debts are bought at a discount. A spin-off, where a subsidiary becomes independent.

Here, the risk does not mainly come from the market. It comes from the event: a judge, a regulator, a shareholder vote.

All these structures have one thing in common: they are expensive. The classic model is called two and twenty.

Two per cent of the capital each year, whatever happens. Plus twenty per cent of the gains, when there are any.

For the example: ten thousand euros of gross gain on one hundred thousand. The manager takes two thousand, then twenty per cent of the rest. You keep six thousand four hundred.

Out of ten thousand euros gained, the manager keeps three thousand six hundred. It takes real talent to be worth the price.

Remember: these strategies do not necessarily seek more return. They seek a return different from the market's.

That is sometimes valuable. But a different return is not always a better one.