Can Long Short Funds really protect your wealth better than equity mutual funds? Or are they just complexity wrapped in smart marketing?
Let us understand what Long Short Funds are, compare them with regular equity mutual funds, and discuss where they may fit - and where they may not.
Read on...
Introduction
Indian investors are constantly being introduced to newer and more sophisticated investment products.
One such category that has gained attention in recent years is the Long Short Fund.
These funds promise lower volatility, downside protection, and the ability to generate returns in both rising and falling markets.
Sounds attractive, doesn’t it?
But as always in investing, complexity often comes with hidden risks, higher costs, and investor confusion.
In this blog, we’ll understand what Long Short Funds are, compare them with regular equity mutual funds, and discuss where they may fit - and where they may not.
What is a Long Short Fund
A Long Short Fund is a type of investment strategy where the fund manager:
- Takes Long Positions in stocks expected to rise
- Takes Short Positions in stocks expected to fall
What is a Long Position
Buying a stock expecting its price to increase.
What is a Short Position
Selling a borrowed stock expecting its price to decline, so that it can later be repurchased at a lower price.
This sounds strange initially because you are selling something before owning it. But this is done by borrowing shares temporarily through the market system.
How Does a Typical Equity Mutual Fund Work
A normal equity mutual fund:
- Primarily buys stocks expected to rise
- Generally, stays fully invested in equities
- Does not usually benefit from falling stock prices
So, traditional mutual funds depend largely on economic growth, corporate earnings, and bull markets
How Does a Typical Long Short Fund Work
Long Short Funds attempt to generate returns even when markets are weak.
Typically, a Long Short Fund:
- Buys (Longs) Infosys expecting good earnings
- Shorts another IT stock expecting weak performance
If Infosys rises 10% and the weaker stock falls 8%, the fund gains from both positions.
In theory, this creates:
- Lower market dependency
- Reduced volatility
- Better risk-adjusted returns
But theory is what it is - theory. The reality is often far more complicated.
Pros of Long Short Funds
1. Lower Volatility
Because the fund profits from both rising and falling stocks, portfolio swings may reduce.
2. Potential Protection in Bear Markets
When markets fall sharply, short positions can offset some of those losses.
3. Diversification
These funds behave differently from traditional equity funds and may be considered for diversifying a portfolio.
4. Less Dependence on Market Direction
The manager tries to profit from stock selection rather than market movement alone.
Cons of Long Short Funds
1. Extremely Complex for Retail Investors
Most investors struggle to understand even the traditional mutual funds properly.
Long Short strategies involve derivatives, hedging, leverage, margin requirements and arbitrage opportunities
This makes the product unsuitable for most ordinary investors.
2. Manager Skill Becomes Critical
In the traditional equity funds, even average managers may benefit from a long bull market.
In Long Short Funds, both the long and short calls must work correctly. Wrong calls on either side can hurt returns badly.
This creates very high dependence on fund manager capability.
3. Higher Costs
Long Short Funds uses strategies involve more trading, derivative positions, research intensity and risk management infrastructure
As a result, their expense ratios are usually higher. Over long periods, costs quietly erode returns.
4. Shorting Has Unlimited Risk
When you buy a stock, maximum loss is your investment amount.
When you short a stock, theoretical losses are unlimited because stock prices can rise endlessly.
This makes short-selling inherently risky.
5. Underperformance During Strong Bull Markets
Long Short Funds often lag during powerful bull runs because short positions drag overall returns.
For example, if the Nifty rises 25%, a traditional equity fund may capture most of that upside.
A hedged Long Short strategy may capture only part of it. This frustrates investors during booming markets.
6. Taxation and Structure Complexity
In India, Long Short Funds may use derivatives extensively. Tax treatment can become complicated depending on structure.
7. Difficult to Evaluate Performance
Many investors compare Equity funds vs Nifty. But there is no such benchmark that can be used for Long Short Funds.
This makes their evaluation difficult.
8. No historical data
India’s formal SEBI-approved Equity Long-Short mutual fund/SIF category is very new, and Quant launched its actual Long-Short SIF only in late 2025.
These funds are yet to prove themselves as worthy challengers.
Who Should Stick to Regular Equity Mutual Funds
Most Indian retail investors are usually better off with diversified equity mutual funds and flex cap funds, or hybrid funds (if lower volatility is needed)
This is especially true if you are a long-term investor, do SIPs regularly, don’t fully understand short selling, and prefer simplicity and transparency
Who May Consider Long Short Funds
These funds may suit very experienced investors, or HNIs with diversified portfolios, investors seeking lower volatility, those who understand derivatives and hedging well.
Tax Implications
It is important for Indian investors to understand that Long Short Funds may or may not qualify as Equity Funds (depending on their equity exposure).
And hence the fund may or may not qualify under equity taxation norms. You need to check for minimum 65% equity exposure to be sure.
Summary
Long Short Funds sound intelligent and sophisticated, but they come with significant complexity, higher costs, and execution risks.
While they may reduce volatility during difficult markets, they often underperform simple equity funds during long bull runs.
For most Indian investors, regular diversified equity mutual funds remain the better path due to their simplicity, transparency, lower cost, and strong long-term compounding ability.
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