Insights

The Case for Long/Short Funds December 2018

For much of this nearly decade-long bull market, you couldn't be wrong if you were long.

However, late in the cycle, the stock market is beginning to show signs of aging with increasing volatility and downside risk. At some point, the headwinds of rising interest rates and inflationary pressures could be too much to overcome. For the first time in years, investors are confronted with the challenge of balancing equity risk with the goal of achieving meaningful returns.

Concerned Investors Looking for Choices

With each wild swing in the market, investors may be reassessing their core investments, searching for strategies that can ease their concerns. However, aside from diversifying further--which can have a diminishing effect on risk reduction--or changing their asset allocation, their options are limited.

For investors who want to remain in the stock market, but who may be getting concerned over the volatility, it's time to consider a long/short equity strategy for their investment mix. Long/short investment strategies have been used for decades by hedge funds, typically the domain of institutional and large investors. The flexibility this type of strategy provides allow it to be more tactical -- giving managers the ability to navigate tumultuous markets.

In recent years, this sophisticated strategy has been made available to retail investors through mutual funds. The benefits of offering this strategy through a mutual fund vehicle allows it to be available to all investors both large and small with more transparency than hedge funds.

What Exactly is a Long/Short Strategy?

A long/short equity strategy is a stock-based strategy in which fund managers assume both long and short positions with the flexibility to vary their exposure to the equity market over market cycles.

The strategy seeks to capture the upside of selected stocks and exploit the downside of others to generate higher risk-adjusted returns.

Generally, an investment manager purchases stocks with expected positive risk/return profiles, while stocks that are expected to decline in value due to deteriorating factors are shorted. There are a wide variety of long/short equity strategies. Some are classified as market neutral, which typically have offsetting long and short exposures that net to around zero. Other strategies have a long bias with varying degrees net equity exposures.

Typically, the objective of a long/short equity strategy is to provide investors with equity like returns with lower volatility during market downturns. While long/short strategies may not outperform the long only indices on the upside in any given year, they are designed to minimize the downside, which can lead to outperformance over the long-term.

Why a Long/Short Strategy Could be Important for Portfolios

A long/short equity strategy can play an important role in portfolios for three reasons:

1. Can Create More Opportunities for Alpha

The ability to short stocks can increase a fund's opportunity to generate alpha without increasing equity exposure. Rather than simply avoiding overvalued stocks, managers can potentially reap gains for the portfolio by selling them short. In addition, managers can use the short sale proceeds to take bigger long positions with the potential to increase portfolio returns. The use of leverage in these circumstances is constrained by regulations.

2. Potentially Reduces Downside Exposure

A fund's short position can be used as a hedge to balance long exposure by reducing market beta. During periods of high market volatility, managers can decrease their net long equity exposure, and increase it during periods of low volatility.

There is no guarantee a fund or strategy will achieve its stated objective.

Chart 1: Why Long Short: Historically Less Volatility vs. S&P 500 Index as of September 30, 2018

The Case for Long/Short Funds, Figure 1

Source: Morningstar Direct. Index returns are for illustrative purposes only and do not represent actual Fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

3. Can Improve a Portfolio's Overall Return/Risk Ratio

A long/short strategy by its very nature implies a more efficient use of risk capital than what can be achieved by a long-only strategy or a broad benchmark. As shown through historical analysis, long/short equity strategies may achieve a higher level of risk-adjusted returns.

Chart 2: Why Long/Short: Historically Greater Growth Vs. S&P 500 Index as of September 30, 2018

The Case for Long/Short Funds, Figure 2

Source: Morningstar Direct. Index returns are for illustrative purposes only and do not represent actual Fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Long Short Equity as a Long-Term Allocation

In longer market cycles, downside risk mitigation can be additive to relative performance. This may make long/short equity strategies attractive to investors as they can provide a cushion for more challenging market periods, while also still potentially benefiting during rising markets.

By adding a long/short equity strategy to a portfolio, investors may complement more traditional assets with added potential diversification benefits. Note that diversification may not protect against market risk.

The Outlook for Long/Short Equity Strategies for 2019

We have experienced one of the longest bull markets over the last 100 years in U.S. equities--with valuations near all-time highs. Also, we've been in a 35-year bull market for bonds with interest rates near historical lows and poised to rise from here. With that in mind, we anticipate higher volatility in equity markets over the next several years as the market comes to grips with the Federal Reserve and other Central Banks around the world raising interest rates.

The question we hear a lot is "What do I do if equity markets fall and interest rates rise?" Liquid alternatives such as a long/short strategy may be considered a great way to help take some risk out of a portfolio, while still providing opportunities for positive returns.


About Hancock Horizon

Hancock Horizon Funds, founded nearly 20 years ago, and its parent company, Hancock Whitney Asset Management, manage over $10 billion in assets for institutional and high net worth individuals, with over $1.1 billion in mutual funds in fixed income, equity and alternative funds as of 9/30/2018.

For more information, please contact Hancock Horizon Funds at 800-990-2434 or information@hancockhorizon.com


Disclosures

Please read the prospectus carefully to obtain a complete understanding of the risks. Read it carefully before you invest or send money. Please see full or summary prospectus for more information on charges, expenses, investment objectives, and risk factors along with information regarding other share classes that are offered for purchase. The Fund's prospectus can be obtained by visiting hancockhorizonfunds.com/FundInvestors/ or by calling 1-800-990-2434.

Mutual fund investing involves risk, including possible loss of principal. Current and future holdings are subject to risk. There is no guarantee the fund will achieve its stated objective. The use of leverage by the fund managers may accelerate the velocity of potential losses. With short sales, you risk paying more for a security than you received from its sale. The risk of loss from a short sale is unlimited because the Fund may purchase the shorted security at a higher price to complete the transaction and there is no limit for the security price. The use of options, swaps or derivatives by the Fund has the potential to significantly increase the Fund's volatility. The Fund may invest in derivatives, which are often more volatile than other investments and may magnify the Fund's gains or losses. In addition to the normal risks associated with investing, investments in smaller companies typically exhibit higher volatility. REIT investments are subject to changes in economic conditions, credit risk and interest rate fluctuations.

The S&P Composite 1500, a combination of the S&P 500, S&P MidCap400, and S&P SmallCap600 indices, provides a broad representation of the entire U.S. market, representing 87% of total U.S. equity market capitalization. The Lipper Long/Short Equity Index category consists of funds that employ portfolio strategies that combine long holdings of equities with short sales of equity, equity options, or equity index options, the fund may be either net long or net short depending on the portfolio manager's view of the market. Indices are unmanaged, and one cannot invest directly in an index.

Horizon Advisers serves as investment advisor for the Hancock Horizon Family of Funds. The Hancock Horizon Family of Funds is distributed by SEI Investments Distribution Co., 1 Freedom Valley Drive, Oaks, PA 19456, which is not affiliated with Hancock Whitney Corporation, Sondhelm Partners or any of its affiliates. Investments may lose value. The Hancock Horizon Family of Funds may not be available in all states.

The material represents the manager's assessment of the market environment at of the date of this writing and should not be relied upon by the reader as research or investment advice regarding any security, nor is it intended to be a forecast of future events or a guarantee of future results.

Alpha is the excess return of an investment relative to the return of a benchmark index. Beta is a measure of volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.

Investments Products: Not Bank Guaranteed | Not a Deposit | May Lose Value | Not FDIC Insured | Not Insured by any Federal Government Agency

Carefully consider the Funds' investment objectives, risks, charges and expenses before investing. This and other information, including performance, can be found in the Funds' full or summary prospectus, which may be obtained by clicking here for a prospectus or by calling 1-800-990-2434 or writing to Hancock Horizon Funds, 2285 Lakeshore Drive, Building 4, New Orleans LA, 70122 for a prospectus. Please read the prospectus carefully before you invest or send money.

Mutual fund investing involves risk including loss of principal.

Investments in smaller companies typically exhibit higher volatility. Microcap companies have a higher risk of failure and typically experience a greater degree of volatility. Investing in microcap companies may not be appropriate for all investors.

International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from social, economic or political instability in other nations. In emerging markets, these risks are heightened.

Bonds and bond funds are subject to interest rate risk and will decline in value as interest rates rise. Bond funds focusing on a single state may be subject to higher volatility. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments.

REIT investments are subject to changes in economic conditions, credit risk and interest rate fluctuations.

Narrowly focused investments typically exhibit higher volatility. Investments in commodities are subject to higher volatility than more traditional investments.

Mortgage-backed securities are subject to prepayment and extension risk and therefore react differently to changes in interest rates than other bonds. Small movements in interest rates may quickly and significantly reduce the value of certain mortgage-backed securities.

MLP's interests are all in a particular industry and the MLP will be negatively impacted by economic events adversely impacting that industry. The risks of investing in a MLP are generally those involved in investing in a partnership as opposed to a corporation, such as a limited control of management, limited voting rights and tax risks. MLP's may be subject to state taxation in certain jurisdictions, which will have the effect of reducing the amount of income paid by the MLP to its investors.

With short sales, your risk paying more for a security than you received from its sales. The risk of loss from a short sale is unlimited because the Fund must purchase the shorted security at a higher price to complete the transaction and there is no limit for the security price.

The use of leverage, options, swaps or derivatives has the potential to significantly increase the volatility and potential losses.

The Dynamic Asset Allocation fund’s investments in Underlying ETFs will subject it to substantially the same risks as those associated with the direct ownership of the securities held by such Underlying ETFs, and the Fund's investments in Underlying ETNs will subject it to credit risk.

Diversification may not protect against market loss.

The Hancock Horizon Family of Funds are available to U.S. investors only and are not available in all states.