The hedge fund offers sophisticated investors an opportunity to earn gains while minimizing risk, regardless of market conditions. This is accomplished via "hedging," which occurs when fund managers use both long and short positions in areas such as equities, derivatives, options and bonds. A long position is a bet that the investment will rise, while a short position bets it will fall; the difference between the two is either "net long" or "net short" exposure. If you wish to calculate net long equity exposure, be sure to factor bonds out of the equation.
1. Ask the fund for the percentage of its equity investments that are long and short. While hedge funds are secretive by nature, fund managers often describe portfolio activity because net exposure is an indicator of where the manager thinks the market is going, For example, a manager might say that he's 130 percent long (borrowing money, or leveraging, to fund 30 percent of his long investment) and 30 percent short. Be sure that the percentages are only equities, and not bonds.
2. Subtract the short percentage from the long percentage. The result is the fund's net long equity exposure.
3. Analyze the result from Step 2. A hedge fund that's 130 percent long equities and 30 percent short equities has a 100 percent net long exposure. This indicates that the fund is making a very strong bet in the "long" direction -- meaning, the manager believes that the stock market will rise sharply in the near future, and if his bets fall in value instead of rise, so will the value of the fund, in proportion to the amount of short exposure he has and how much that short exposure increases as the long exposure falls -- hence, hedging.
- To calculate the percentage of leverage that a fund is using to invest, subtract 100 percent. For example, a fund that's 120 percent long is 20 percent leveraged -- meaning, the fund borrowed 20 percent of the value of the investment to place its bet.
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