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Understanding Equity-Long Only Strategy

There are a number of advantages to a long-only hedge fund. Primarily, there is more room to calibrate the right investment position and greater scalability in those investments. While hedge funds shorting equities may not only find it difficult to get in a certain position but also to acquire enough shares to make the position profitable, there is less concern in maintaining a long position that can be gradually increased over time with minimal leverage. Long-only hedge funds can target certain sectors, for example small cap manufacturers with exposure to emerging markets, while hedging broader exposure to market risk. This is one key difference between most long-only hedge funds and traditional long-only funds: hedge funds do not usually invest or benchmark to a market index (except maybe as a hedge), they attempt to find specific areas of investment where alpha can be generated.

The main disadvantage to the long-only strategy is potential competition from other asset managers and the management cost of hedge funds. The reason long-only funds were not a prominent feature of the early hedge fund space was that investors were looking for larger returns and a more actively managed fund. Investors were also willing to pay for it, typically paying hedge fund managers 2% of total asset value plus 20% of generated profits. As hedge funds adopt more orthodox investing strategies, however, there is a conflict between fees charged by hedge fund managers and regular fund managers, which are significantly lower. It could be that long-only funds generate sufficient returns to merit higher remuneration, it also might mean that long-only funds seek new compensation models in order to remain competitive.

In spite of the similarities, long-only hedge funds look like they are here to stay. While some industry veterans may still be uncomfortable with the notion of a long-only hedge fund, the expansion of hedge funds into different niches may be showing an evolution of the asset class and a broader understanding in the investment community of alpha. Indeed, the initial coupling of alpha with "active" management may be gradually changing as long-only funds' returns rival those of other funds adopting more contrarian investment strategies.

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