Kevin Gray, Chief Investment Officer at Fortem Capital, shares his insights on how many discretionary equity long/short funds deliver returns driven largely by unstable equity market exposure (beta), rather than genuine alpha, while charging high fees for what is often repackaged factor and market risk.
Equity long/short has long been considered one of the more credible additions to a diversified portfolio. It promises reduced market exposure, smoother returns through cycles and actual diversification from the delta-one allocations that already dominate most client portfolios.
The reality is more complicated.
Fees are high, betas drift unpredictably, and the alpha that investors are paying for often turns out to be little more than disguised equity exposure.
For advisers and discretionary managers building multi-asset portfolios, this matters a great deal. If a long/short allocation is simply repackaging the same factor exposures already present in a client’s core equity holdings, then the diversification benefit is illusory and the fee drag an anchor.
The problem with discretionary long/short
The traditional case for long/short rests on the manager’s ability to generate alpha from both sides of the book. In practice, the evidence for persistent single-manager alpha is thin.
The academic foundations of modern factor investing, established by Fama and French and extended by Carhart to include momentum, demonstrate that much of what passes for alpha is in fact systematic exposure to well-documented risk premia: value, quality, size and momentum.
Discretionary managers tend to run higher equity betas than their mandates might suggest. To a degree, this is rational. Equity markets have historically delivered a positive return over time, and a portfolio that carries some sensitivity to that broader market performance will tend to benefit from it.
The problem arises when that sensitivity is neither deliberate nor stable. When beta creeps up quietly through manager discretion, shifts unpredictably across market regimes, and is then presented to investors wrapped in a fee structure for genuine alpha generation.
The result is time-varying beta delivered under the guise of alpha generation, with a fee structure that implies far more is going on. In an era where a handful of large-cap growth stocks have come to dominate global equity indices, many long/short funds are more correlated with standard equity allocations than investors appreciate.
The diversification benefit they were meant to provide has quietly eroded.
Cost and complexity
The short book is where much of the problem lies. Generating alpha from single-name shorts is difficult. Borrow costs are elevated, payoff profiles are asymmetric and operational overhead is considerable.
When you combine these frictional costs with a fee structure already set at hedge fund levels, the return hurdle for the strategy to add value becomes very high.
Index-based shorting instead offers a cleaner, more efficient approach to managing beta rather than generating alpha on the short side. The benefits are practical and compound over time with lower borrow costs, simpler operations, better liquidity and a more stable net beta that behaves consistently across market regimes rather than drifting unpredictably.
Synthetic replication
The structural evolution that drove major ETF providers to embrace synthetic replication for long-only index strategies applies equally in the long/short space.
Where counterparty and collateral frameworks have matured under UCITS, synthetic replication now represents a highly efficient way to implement index exposure. It frees the fund’s balance sheet for a fixed-income collateral portfolio, adds a visible income return and reduces the frictional costs that erode performance.
It is not a compromise. It is a deliberate design choice that prioritises cost efficiency, liquidity and return predictability over the uncertain pursuit of idiosyncratic short-side alpha.
What the data shows
Analysis of a broad peer group of equity long/short managers over the decade to October 2025 reveals a familiar pattern. Strategies with higher headline returns frequently achieved them through higher volatility and higher drawdowns.
More telling still, elevated beta is often what is driving those returns, and that beta has not been stable. Investors holding such strategies may have paid hedge-fund prices for exposures that could have been obtained far more cheaply elsewhere.
A systematic approach that targets persistent factors on the long side, such as value, quality, momentum and size, provides a meaningful structural differentiation from a global equity index now dominated by a handful of mega-cap technology stocks. The Mag 7 now represent a larger share of the global equity benchmark than the combined stock markets of Japan, the UK, France, Canada and Germany, making additional exposure through a long/short strategy largely redundant for portfolios already heavily invested in these themes. Importantly, the objective is not to eliminate equity beta entirely. Equity risk has historically been rewarded and investors are likely to benefit from retaining some exposure to it. The key distinction is that beta should be deliberate, stable and cost-efficient, rather than an unintended by-product of manager discretion.
True diversification
The argument for a well-constructed systematic long/short strategy is not that it will automatically top the performance tables. It is that it provides a stable, low-beta, cost-efficient diversifier that does what it is designed to across different market conditions, including during periods, such as 2022, when equity beta was a significant drag on returns.
For IFAs and DFMs building robust portfolios, that kind of predictability has real value.
The role of a core long/short allocation is to provide a reliable foundation; dependable enough to hold with confidence and efficient enough to justify its place in the portfolio on pure cost-benefit terms.
As fees continue to attract scrutiny and clients become more attuned to what they are really paying for, the question every adviser should be asking of any long/short allocation is straightforward: how much of this return is truly diversifying, and how much is equity beta with a complicated wrapper around it?
Kevin Gray is Chief Investment Officer at Fortem Capital
