Market Volatility and the Return of Long/Short Equity

Written by Steven Grabowski - Co-Head of Capital Introduction

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We have been increasingly hearing about renewed appetite for hedge funds from institutional allocators over the past year. That momentum has continued and what investors have been telling us is now showing up in the data. While many hedge fund strategies are benefiting from this renewed interest, we are witnessing a strong rebound in flows to long/short equity. According to data from Hedge Fund Research, long/short equity funds brought in $10 billion in assets during the first half of 2025. In this quarter’s capital introduction update, we explore this trend further.

We expect the increase in interest and in actual flows to long/short equity to continue as there are multiple tailwinds for the strategy. First, allocators are reallocating any available liquidity from their private investments back into other areas of the portfolio. Second, at the time of writing in early August, we see sustained equity market volatility, most recently driven by the jobs report and the implementation of tariffs. Investors often express greater trust in stock picking expertise when there are concerns about overall market performance and direction. And flexible long/short equity managers can adjust their net exposure and quickly adapt to broader equity market swings and individual stock price movements. Global long/short managers have an additional lever that allows them to rotate their geographic exposure.

Institutional portfolios tend to make asset allocation adjustments like aircraft carriers make turns. Strategic allocations are built for the long-term and even tactical changes tend not to be drastic. Implementation decisions for many large institutions like endowments, foundations, pensions, and large family offices require the approval of investment committees and/or boards that meet quarterly. And, as we noted in last quarter’s update, private investments often have limited available portfolio liquidity. Therefore, the increased flows into long/short equity reflect that deliberate shift and align with what we’ve been hearing from allocators over the past year.

Strong performance by many long/short equity funds (and other hedge fund strategies) in the first half of 2025 has helped support the case for the strategy. The best performers in the first half of this year were able to offer ballast during the market volatility in March and April while still participating in the recent market run-up. As a result, these top managers have strong double digit returns that far outpace the S&P 500’s first half of 2025 return of 5.5%. But there is not one reason that these top managers have outperformed the market during this period. Long/short managers add value to investors through:

• Making nimble adjustments to their net exposure and individual holdings
• Rotating capital to securities in geographic regions that trade at lower valuations
• Shorting mispriced individual securities to generate alpha in their short books

In our conversations with investors in the U.S., we have seen increased interest in traditional long/short equity with 50%-70% net exposure as well as lower net (<40%) and market neutral strategies. Our colleagues in London report that interest from European investors in low beta and market neutral strategies far outweighs that of long/short managers with higher directionality. In simple terms, investors who want to more drastically reduce their beta exposure tend to favor lower net strategies. Investors who are less concerned about their market exposure and believe they have identified excellent stock pickers may be more focused on higher beta long/short managers. But, as we have mentioned in previous reports, every investment decision requires a funding source (private investments, long equities, cash, and bonds), so it’s impossible to know the reasoning behind the moves of individual allocators. That fact does not change the fact that there is renewed interest in long/short strategies across the board.

While flows into long/short equities are evident already, we would argue that these flows are green shoots that are indicative of a larger trend that will benefit long/short equity managers. Those long/short equity managers who can show their ability to add value, communicate clearly with investors, and offer reasonable fees and liquidity will likely see increased inflows to a strategy that appears to be seeing a rebirth in interest and investment.