Long/Short Equity Explained: How the Strategy Works, Market Neutral and Related Approaches

Long/short equity is a hedge fund strategy that buys shares expected to rise and sells short shares expected to fall, so that returns depend more on stock selection than on the direction of the overall market. It is one of the oldest and most widely used hedge fund approaches — and the starting point for related strategies such as equity market neutral, long/short credit and event driven investing. This guide explains how long/short equity works, how to read a fund's exposure, and where the risks sit.

What Is Long/Short Equity?

A long/short equity fund holds two books at the same time: a long book of stocks the manager believes are undervalued or improving, and a short book of stocks the manager believes are overvalued or deteriorating. Short positions are created by borrowing shares and selling them, with the aim of buying them back later at a lower price.

The short book serves two purposes. It can generate returns in its own right when the shorted companies underperform, and it offsets part of the market risk carried by the long book. That second function is what puts the "hedge" into hedge fund — a point covered more broadly in our overview of what hedge funds are and how they work.

How Does a Long/Short Equity Strategy Make Money?

A long/short equity strategy makes money when its long positions outperform its short positions. If the longs rise more than the shorts, or fall less than the shorts in a declining market, the fund can earn a positive return even when the broader index moves against it.

In practice, returns come from three sources:

• Long alpha — picking stocks that outperform their peers or the market.
• Short alpha — identifying companies that underperform, for example because of weak balance sheets, disrupted business models or stretched valuations.
• Residual market exposure — most long/short funds keep a net long bias, so part of the return still reflects the direction of the market.

Because the result depends on the spread between winners and losers, long/short equity tends to benefit from high dispersion — markets in which individual stocks move very differently from one another. We discuss why dispersion matters in the current environment in hedge fund strategies in times of market fragmentation.

Gross vs Net Exposure: How to Read a Long/Short Fund

Gross exposure measures how much capital is at work in total; net exposure measures how much market direction the fund is actually taking. Both are expressed as a percentage of the fund's capital.

• Gross exposure = long positions + short positions. It indicates overall activity and leverage.
• Net exposure = long positions − short positions. It indicates sensitivity to the market's direction.

As an illustrative example, a fund that is 120% long and 70% short has gross exposure of 190% and net exposure of 50%. It is therefore still meaningfully exposed to the market, but far less than a fully invested long-only fund. Two funds with the same net exposure can carry very different risk if their gross exposure differs, which is why investors should always ask for both figures.

Types of Long/Short Equity Strategies

Long/short equity is a family of approaches rather than a single strategy. The main variants differ in how positions are selected and how much net exposure the manager takes:

• Fundamental long/short — bottom-up research on individual companies, often concentrated in a limited number of high-conviction positions.
• Quantitative long/short — systematic models that rank large universes of stocks on factors such as value, momentum or quality.
• Sector specialists — managers focused on one area, such as technology, healthcare or financials, where specialist knowledge can create an edge on both sides.
• Variable net / directional — managers who actively move net exposure up or down depending on their market view.
• Short bias — strategies that deliberately run more short than long exposure, typically used as a hedge within a broader portfolio.

Long/Short Equity vs Equity Market Neutral: What Is the Difference?

Equity market neutral is a stricter form of long/short equity that aims to keep net market exposure close to zero, so that returns come almost entirely from the spread between longs and shorts. A traditional long/short equity fund, by contrast, usually keeps a net long bias and accepts some market risk.

Market neutral managers typically balance their books not only by dollar value but also by beta, sector and style factors, so that a broad market move has as little effect as possible on the portfolio. Hedge Fund Research reflects this relationship in its strategy classification, where equity market neutral sits as a sub-strategy of the wider equity hedge category. The trade-off is that market neutral funds give up most of the upside in strong equity markets in exchange for lower correlation — a profile closely related to absolute return strategies.

Beyond Equities: Long/Short Credit and Event Driven Strategies

The long/short logic is not limited to shares. Two closely related strategies apply it to other parts of the capital structure and to corporate events.

Long/short credit

Credit hedge funds apply the same principle to corporate bonds, loans and credit derivatives: they buy the debt of issuers whose credit quality they expect to hold up or improve and sell short, or buy protection on, issuers they expect to weaken. Returns come from changes in credit spreads and from the income the long positions generate, which makes long/short credit less dependent on equity market direction.

Event driven

An event driven hedge fund positions around specific corporate events — mergers and acquisitions, spin-offs, restructurings, bankruptcies or changes in capital structure. The best-known example is merger arbitrage, which seeks to capture the gap between a target company's share price and the announced deal price. Here the key risk is not market direction but whether, and on what terms, the event actually happens.

Related relative value strategies, such as convertible arbitrage or capital structure arbitrage, also combine long and short positions in securities of the same issuer to exploit pricing differences between them.

What Are the Risks of Long/Short Equity?

Long/short equity reduces some market risk but introduces risks that long-only investors do not face. The most important are:

• Unlimited loss on shorts. A long position can lose at most the amount invested, whereas a short position can in theory lose without limit, because a share price can keep rising. The SEC's investor bulletin on short sales sets out this and other mechanics, including margin requirements and borrowing costs.
• Short squeezes. When a heavily shorted stock rises sharply, short sellers may be forced to buy back at the same time, pushing the price even higher.
• Crowding and factor risk. If many managers hold similar longs and shorts, positions can move against them together, and hidden factor exposures can dominate returns.
• Leverage. High gross exposure magnifies both gains and losses.

These risks often show up in the tails of the return distribution rather than in average volatility — which is why measures such as those discussed in skewness and kurtosis in hedge fund returns are useful when comparing managers.

What Role Can Long/Short Strategies Play in a Portfolio?

Long/short strategies are generally used to keep equity participation while reducing dependence on market direction. Because of their lower net exposure, they tend to be less sensitive to broad market moves than long-only equity funds, although this is not guaranteed and varies widely between managers.

Outcomes differ more between individual long/short managers than between long-only funds tracking the same index, so the quality of the manager matters more than the label. Our guide on hedge fund manager selection explains how to separate repeatable skill from luck.

How AQUIS Capital Uses These Strategies

AQUIS Capital, a Zurich-based asset management boutique licensed by the Swiss Financial Market Supervisory Authority (FINMA), combines several of the strategies described above in the AltAlpha SICAV – Abacorum Fund. The fund of hedge funds allocates across long/short equity, long/short credit, global macro and event-driven strategies, aiming to diversify the sources of return rather than rely on any single one. How such combinations differ from a single multi-strategy platform is explained in our article on multi-strategy hedge funds.

Frequently Asked Questions About Long/Short Equity

What is a long/short equity strategy?

A long/short equity strategy buys stocks expected to outperform and sells short stocks expected to underperform. The goal is to earn returns from stock selection while reducing, but usually not eliminating, exposure to the overall market.

Is long/short equity market neutral?

Not necessarily. Most long/short equity funds keep a net long bias, while equity market neutral funds aim for net exposure close to zero. Market neutral is best understood as a stricter sub-type of long/short equity.

Are long/short funds risky?

Long/short funds usually carry less market risk than long-only equity funds, but they add risks of their own: potentially unlimited losses on short positions, short squeezes, crowding and leverage. The actual risk depends heavily on gross and net exposure and on the manager's discipline.

What is net exposure in a hedge fund?

Net exposure is the value of long positions minus the value of short positions, expressed as a percentage of capital. It shows how much the fund depends on market direction; gross exposure, the sum of longs and shorts, shows how much capital is at work overall.

What is an event driven hedge fund?

An event driven hedge fund invests around corporate events such as mergers, spin-offs, restructurings or bankruptcies. Its returns depend mainly on the outcome of those events rather than on the direction of the stock market.

Read more about AQUIS Capital and the team behind it, explore the AQUIS Capital fund range, or contact the team with your questions.

This content is for general information only and is not financial, investment, tax or legal advice. Investments carry risk, including the possible loss of capital. Consult a licensed professional before making decisions.