This Long-Short Fund Beat the Market by 37 Points (Here's the Math)

In 2022, the S&P fell 18%. But there was a mutual fund that held nothing but stocks. Long some, short the others, and it finished up 19%. Same year, same market, and a 37% difference. There was no crystal ball, no market timing, just stocks they liked on one side and the other that they didn't. That fund has a cousin now. and a whole category of long short funds you can buy in a normal brokerage account. So I ran the five biggest ones through the same math we use in our own fund to evaluate strategies. Here's what I found. Two of them are the real thing. Two of them are basically repackaged index funds charging hedge fund prices and one of them isn't even trying to make money. It's a completely different strategy. I'll show you which one is which. The four-step test that tells them apart. You can run it yourself in a spreadsheet in just an afternoon. And what happened when I split the money evenly across the three funds that passed? That last number is the best part of the video. This is all education, not recommendations. Let's get into it. Let's start with the results and work backwards from there. QX QL EIX. This one's real. It's AQR's long short equity fund. And AQR is basically the shop that wrote the research on all of this. Over the full test window, it made about 20% a year. But here's the part that matters. It did that with an 8% volatility, which is about half of the stock market. And its worst draw down was only 3.5% at month end. And here's the numbers that should stop you. In the months when the market went down, this fund on average was up. That's what an actual hedge fund strategy is supposed to do, but almost none do. It's also got a real track record, running since 2014, and it made about 19% in 2022 when everything else that was stocks was falling. The catch is that it's soft close to new money, which honestly is what you'd expect from a fund that is actually this good at it. CLSE, also real with a nuance. This one's a ranking machine. It scores about a thousand US companies on things like value, momentum, balance sheet quality, and debt. They add up all those scores and then they buy the ones at the top of the list and short the ones at the bottom of the list. Over our window, it made about 26% a year and turned $10,000 into 14,400 in that same year and a half. Now, here's what our test caught. Most of what it's doing is just being in the stock market. It moves with the market almost as much as an index fund does. But after you strip all of that out, there's still about 6% a year left over that the market doesn't explain in terms of its returns. So it has real skill riding on top of real market exposure. You just want to know which part you're buying and which part you're paying for. ORR, real but with an asterisk. This one is a single guy running a quality versus junk stock picks. best raw number on the list about 26% a year and almost none of it came from the overall market return. In down months, it went up more reliably than even the AQR fund did over the same period. So, what's the asterk for? It's one human being with a relatively short track record and you're looking at his best year and a half. Is that skill or is it a hot hand? Honestly, the data cannot tell us yet. That's what people mean when they say single manager risk. FTLS. This one's repackaged. The strategy sounds smart. It shorts companies that book revenue before the cash actually shows up or acrruels, which is a red flag with real research behind it. But when we tested it, about half of its returns were from the S&P and the other third was from the quality factor, which you can buy in a lowcost ETF for a quarter of a percent. And after all that, it still trailed the beta of the market. So you're paying hedge fund fees for ingredients you can mostly replicate at the grocery store. BTA, not repackaged, just a completely different tool. This one is built to move against the market. When stocks go up, it loses. That's not the bug. That's the entire job. If you saw my video on assets that lose money on purpose, you know where this one belongs. It just doesn't belong in this comparison. So that's the scoreboard. The obvious question is how do you know and how do you tell real skill from repackage index exposure? That's the test. Here's the thing that reframes all of this. CLSE beat the market by about 14%. This sounds incredible, but most of that was explained by momentum and momentum had a great run and this fund leaned heavily into it. Growth ripped and the lean on growth did too. You could have gotten most of that ride of the growth from ETFs that cost you a quarter of a percent over the same year. SPY for the market and SPMO for momentum. AVGV for the value, QA for quality, VUG for growth. So, did it beat the market is the wrong question. The right question is did it beat the cheap version of itself in an ETF. If you can get the same performance from a cheap ETF, you shouldn't pay hedge fund prices. The only thing worth the fee is the difference after the ETF performance is accounted for. The difference has a name. It's called residual and that's what the test measures. Four steps and you can do this in a spreadsheet in an afternoon. Step one, download the daily returns for the funds you're checking plus those five cheap factor ETFs. Any charting site gives you this for free. Step two, run a regression. It's one formula in Excel. All what it's really asking is what mix of the cheap ETF moves most like this fund. Step three, read three numbers. How much of it is the market or risk known as beta? How much of it is the factor exposure or the ETF? And how much of it is left over or the skill or alpha of that manager? That's the residual. Step four, judge the leftover. Is it bigger than what they're charging you? How many years of it do they have? Because two years of anything is a rumor, not a track record. And is it a process or is it a single person? That's exactly how FTLS got caught. Half of the market beta, a third the quality factor, and then nothing left over. And it still lost to the index. And it's how Culix passed almost nothing explained by beta, and over 6% a year left over for a full decade. One extra move. If you want to be thorough, check how much of the market exposure the fund had over time, not just on average. If a manager almost had none in 2022 and a lot today, they're actually turning the dial. And that's a real skill, but it means you can't treat their market exposure as a fixed number. Quick break. Today's sponsor is MBH Capital Management. Yes, my fund. And finding returns the indexes can't explain is basically our whole job over here at MBH. MBH1 is our zerodt engine and MBH2 is our multi strategy fund. Quick word on the fund. If you're a verified accredited investor and want to see our offering documents for MBH1 or two, you can book a call in the link below and we'll walk you through the PPM. That's the documents for the offer, not me talking on YouTube. If you're not accredited, no worries. The education is still the point. Back at it. Quick detour into why long short is even a thing. You can pick the right stock and still lose to the S&P. It happens to Warren Buffett. Berkshire generally picks great companies and the index still walks away from them. Here's the math on that. Say your pick beats other stocks by five points a year. Real skill, but it's stable. A boring company, so it carries less market exposure than the index does. Call it five points less. Your skill made you 5%. Your caution cost you 5%. And you end up flat. You were right. and the scoreboard says you lost because you had less risk. Long short fixes that. A stock picker can actually have two opinions. The companies they love and the companies they think are garbage. If you go long the ones you love and short the ones you hate, you're using both opinions and the short side cancels out most of what the market has. What's left is actual picking. That's how a fund holding nothing but stocks makes 19% in a year the market lost 18. And one myth while we're still here. People say shorting must cost a fortune with rates of 4%. It doesn't. When you short a stock, the cash from the sale earns interest. When you borrow to go long, you pay interest. Run both at the same time, and the rate mostly cancels out. You're only paying the small gap between the two, which is roughly about a half a percent. That's true whether rates are 1% or 30. Same lesson as my leverage videos. It's never the rate. It's the gap between the financing cost. The real cost is the fee and the taxes from all that trading and the one that nobody thinks about. How far your return can drift from the market. Which brings us to the honest part. Now, let's talk about dispersion, which is how individual stocks in the index move compared to the overall index. Stock pickers need dispersion. Option sellers need volatility. From 2017 to 2020, there was basically zero dispersion. Everything moved in lock step and no amount of skill can harvest a gap that isn't there. Funds like these looked useless for years. The way I like to explain it to people, low dispersion is both your kids being sick the same night. Nothing you do makes that evening good. High dispersion is being at Disneyland. One kids loved Mickey. One kid is terrified of him. And a good parent can still make it a great day because kids are reacting to different stimuluses. Now, the honest part dispersion right now is near its highest level in 30 years because a handful of AI names are carrying the whole index while everything underneath it does its own thing. So, these funds are having an amazing stretch and some of what looks like brilliance is just really good conditions. When that reverts, and it always has, the exact same skill will print worse numbers, and most people will quit right before that cycle turns. Three doors, none of them wrong. This is general education, not a prescription. Door one, just buy the index. It's free. You're guaranteed to get the average. There's zero drama in a completely respectful answer. Door two, cheap factor tilts. own ETFs for momentum and value like SPMO or AVGV. They offset one another. They're nearly free in terms of fees and historically worth about a point or two a year if you're patient over a long time horizon. Door three, pay the high fees for the funds that pass the test. If you go there, keep three things in mind. First, don't just use one. And here's the interesting part. These three funds barely move together at all. a ranking machine, a factor shop, and one discretionary guy disagrees with one another constantly, which is exactly what you want. Their correlations to each other are very low and close to zero. Second, remember that some of this is just market exposure, mostly from CLSE. So, count it inside your stock allocation. Don't pretend like it's a different strategy. Third, size it so it matters, but doesn't take over. My rule of thumb, under about 20% your stock allocation, it can't move the needle enough to be worth the annoyance. Over 40% you're basically giving up the index exposure. Somewhere in between, pick a number and stop fiddling with it. And one last thing, the expense ratios on these looks insane. ORR can show almost 10% gross. That's not a management fee. That's accounting, including the cost of running the short side. It's already inside the returns you just saw. Judge the net number, not the sticker number. All right. Now, the number I promised. Take the three funds that passed and split the money evenly. A third, a third, and a third. No optimizing, no timing, no genius. The dumbest possible allocation to combine them. $10,000 turns into $14,193 over a year and a half. That's about 25% a year. And it did that with 6 and a half% volatility which is roughly one-third of the stock market. Its worst draw down at the end of month only 3.4% and only three losing months out of 19. Look at what combining them did to the pain. CLSC's worst month by itself was down almost 5%. OR's worst month was down almost 7. Then you blend them and the worst month is only 3.4 because they never had a bad month at the same time. This is the whole idea. A return near the best fund in the entire group at a fraction of the market's risk from three things that don't move together. That kind of profile is what big multi- strategy hedge funds get paid two and 20 to build. And you just watched it get assembled out of three tickers with an annual rebalance. Now, the cold water because you know the rules are here. This is 18 months. That's an audition, not a track record. My video on sharp error bars can explain how little you can conclude from this short of a window. Dispersion is at a 30-year high right now, and some of that is baked into those numbers. So, the claim isn't that this continues. The claim is that the construction works. Find real leftovers, use more than one, count your market exposure, and hold it. Whatever the data says next wins. Quick recap. A stock fund made 19% in a year the market lost 18%. Because long short equity lets you use both your opinion instead of one. Did it beat the market is the wrong question. Did it beat the cheap version of its factor exposure is the right one. And the four-step test answers it. QX and CLSE passed. O passed with an asterisk. FTLS is a repackage index exposure and BTAL is a different tool entirely. Shorting cost are a small gap in the financing spread, not the entire interest rate. And over this short window, by splitting the allocation between the three, they had significantly less volatility and a much better risk adjusted return with still beating the index. This is education, not advice. And I'm not going to answer should I buy X in the comments. But here's what I will read. Run the four-step test on the funds you own and post what you find. Best and worst results will get pinned in the comments. If you're a verified accredited investor and want to see our offering docs for MBH1 or MBH2, you can book a call below. We'll walk you through the PPM. That's the offer, not me speaking on YouTube. Not accredited? No worries. The education's the point. I'll see you guys in the next one.