Long-short funds: Check if shorting aims to cut risk or boost returns

Invest only if you are clear about the fund's strategy, risks, and role in your portfolio

At least 10 asset management companies (AMCs) are preparing to launch long-short equity funds for high-net-worth individuals. These will operate under the Securities and Exchange Board of India’s (Sebi’s) new Specialised Investment Fund (SIF) framework, effective April 1, 2025, which mandates a minimum investment of ₹10 lakh. Sebi has introduced seven categories of long-short funds: three equity-oriented, two debt-oriented, and two hybrid.

 

How these funds work 

Long-short funds aim to generate returns in both rising and falling markets by taking long positions when prices are expected to rise and short positions—via futures or options—when prices are expected to fall. “This dual ability allows the fund manager to play both sides of the market and generate potential returns regardless of market direction,” says Radhika Gupta, managing director and chief executive officer (MD & CEO), Edelweiss Mutual Fund.

 

“The fund manager also has the flexibility to hedge their portfolios or create option strategies to benefit from market volatility,” says Vaibhav Shah, head – products, business strategy and international business, Mirae Asset Investment Managers (India).

 

Higher return and risk 

These funds offer greater flexibility than traditional mutual funds, which are long-only and gain only when prices rise. In falling markets, they either stay out or decline alongside. SIFs can take naked (unhedged) short positions up to 25 per cent of the portfolio value.

 

“SIFs allow fund managers to identify opportunities and go short on some stocks. If the call goes right, the fund gains value, helping not only in capital protection but also return generation,” says Anand Vardarajan, chief business officer, Tata Asset Management.

 

Shah adds that their flexibility enhances the potential of these funds to generate alpha in range-bound and bearish markets as well.

 

While these funds could offer higher upside, they also come with higher risks. “Both long and short calls can go wrong, leading to dual-sided losses. If not managed well, these strategies can result in significant return volatility,” says Gupta.

 

High risk appetite a prerequisite 

These funds, which require a minimum ₹10 lakh investment, are suited for seasoned investors. “Long-short SIFs are designed for seasoned, high-risk, high-reward investors, who understand market volatility,” says Shah.

 

Santosh Joseph, chief executive officer, Germinate Investor Services, considers a good understanding of market cycles a prerequisite. “They should not be treated as get-rich-quick schemes. Investors must have the patience to let these strategies play out,” he adds.

 

Gupta emphasises that these funds can suit a range of risk profiles. “Conservative investors may prefer strategies that use short positions primarily to hedge risks. Aggressive investors may opt for funds that take active short calls to generate alpha,” she says.

 

Vardarajan cautions that first-time investors should steer clear of them. “Investors who prefer simple strategies should also stay away due to their complex nature,” says Abhishek Kumar, Sebi-registered investment advisor and founder, SahajMoney.com.

 

Allocation and horizon 

Long-short equity funds fall at the aggressive end of the equity spectrum. Kumar suggests allocating 10–20 per cent of the equity portfolio, depending on the investor’s risk appetite. “These funds can partially replace traditional equity exposure, but should not be core holdings,” he says.

 

Joseph recommends a five-year horizon due to their complexity and risk profile. Kumar adds that a three to five years would help assess fund manager performance across cycles and account for higher fees and volatility.

 

Holding periods can vary based on the fund’s risk profile. “Lower-risk SIFs may require shorter horizons,” says Joseph.

 

Advisors urge caution initially. “Wait for 12–18 months for a track record to develop. Even though established AMCs are launching them, these new products do not have an India-specific performance history,” says Kumar.

 

Joseph advises investing only after assessing their performance against traditional mutual funds and understanding the role they will play in portfolios.

 

“Check whether the SIF is aiming for risk reduction or return enhancement. Read the fund’s strategy and risk disclosures carefully,” says Gupta. 

Do the due diligence

 

Understand liquidity profile (how quickly and easily you can exit)

Understand tax treatment

Conduct due diligence on fund manager experience

Monitor fees

Review performance vis-à-vis long-only funds

The writer is a Delhi-based independent financial journalist