CLSE: Impressive for a long/short fund

Long/short strategies have struggled over the past decade in general. Going long only and having full exposure to the S&P 500 was clearly the winning trade. But that doesn’t mean the next 10 years can’t be different In fact, I think there’s a lot of opportunity in the space as stock picking comes back, and if you agree, you might want to consider the Convergence Long/Short Equity ETF (class-). This strategy manages a mix of long and short positions to take advantage of market gaps and produce better risk-adjusted returns. This fund uses a dynamic quantitative model to actively build a portfolio of long and short equity positions. Unlike traditional long-only strategies, CLSE’s two-way approach aims to take advantage of both rising and falling stock prices, providing a diverse source to generate alpha.

The CLSE investment the philosophy is based on the idea that markets are not always efficient and undervalued or overvalued stocks can create profitable opportunities for smart investors. By examining a wide range of fundamental data, fund managers try to find companies with strong fundamentals for their long positions and those with weak business models for their short positions. It does this through a process that combines quantitative and fundamental methods, which they call a “quantamental” approach. This blended strategy combines the bottom-up fundamental analysis of experienced managers with quantitative tools and state-of-the-art technology. Using huge data sets and advanced algorithms, the fund tries to find and profit from market inefficiencies that old-school stock picking might miss.

A look at the portfolio

The long side was clearly well chosen as we can see a strong focus on technology, with Nvidia (NVDA) on top. The weightings are modest, so it is not a fund with a high concentration in top holdings, as we see in other long-only strategies. Notice here the cash position, which is the effect of the long offset by the short allocation.

CLSE’s short positions focus on companies that have fundamental flaws, are losing market share or have business models that cannot last. The Fund selects and closely tracks these positions to reduce the risks associated with short selling. Note that individual company short positions have less exposure than top long positions. I think this makes sense given that shorting is notoriously difficult and you want to be even more diversified there just in case there’s a bigger gap that could pop up at any time.

Current net exposure is 65%, which explains the cash allocation (longs minus shorts).

Sector composition and weights

CLSE’s portfolio is spread across various sectors. The fund’s long exposure is currently dominated by tech, as it should take into account how well that sector has performed. Finance ranks second, followed by health.

The interesting thing is that the biggest short allocation also goes to Tech. I actually really like this because it’s clear that managers are doing spread trades within the sector, going for short winners and short losers (eg short Intel long Nvidia).

Peer comparison

While CLSE does not have a monopoly on the long/short equity strategy, its quantitative approach and hands-on management make it stand out from many similar funds. To get a clearer picture of where it stands, we should compare CLSE’s performance and what makes it unique against a proxy for the total stock market to see if the fund’s positioning causes it to outperform. When comparing the CLSE to the S&P 500 ETF (SPY), we find that the fund has outperformed the S&P 500 since inception, but has generally been in a wide range. Still impressive considering it’s been incredibly hard to beat the large caps this cycle given how dominant they’ve been.

Pros and cons

On the positive side, by taking an active role in managing long and short positions, CLSE seeks to create value from multiple sources, which could lead to better risk-adjusted returns over time. The fund’s ability to profit from both rising and falling stock prices can provide a diverse way to create value that traditional strategies that buy stocks cannot. Furthermore, short CLSE positions do more than just hedge; they serve as active alpha sources. When markets crash, these short positions can offset losses in the long portfolio. This provides some downside protection and helps reduce the overall ups and downs in the portfolio. Although CLSE looks like an interesting investment option, it is essential to recognize and weigh the possible risks and disadvantages related to this strategy.

The downside? The short sale itself. While a key part of the CLSE approach, shorting has its own risks. When a stock you’ve shorted goes up in price, you can lose a lot of money. There is no limit to how high a stock’s price can go, so your losses could continue to mount. Also, short sellers may face higher costs to borrow shares and may have difficulty finding enough shares to borrow, which may affect how well the fund does. In addition, CLSE’s hands-on management and use of short positions make things more complicated than simple buy-and-hold strategies. This added complexity often means you’ll pay more in fees and costs (total expense ratio of 1.55%), which can hurt your profits over time.

Conclusion

The Convergence Long/Short Equity ETF takes a different approach to equity investing. It has the potential to increase risk-adjusted returns through its flexible long/short strategy. CLSE aims to make the most of market inefficiencies and deliver better performance while reducing volatility. It does this by managing long and short positions. In fact, I find it impressive how well the fund has done overall, and I think the stock-picking opportunities going forward will provide a broader tailwind here. This is an ETF worth considering.

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