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Why L1 Capital’s Long Short Fund still looks a good bet

One of the biggest cash raisings this year came from funds management business L1 Capital who managed to raise $1.3 billion for its new L1 Long Short Fund Ltd (ASX: LSF) on the back of several years of delivering stellar returns for early investors.

In fact the original L1 Long Short Fund’s annualised return of 36.8% a year to investors since September 2014 (according to the IPO prospectus) is what powered an exceptionally strong raising from investors probably hoping these kind of returns could be maintained.

However, L1’s Long Short Fund has made the news lately due to its disappointing start with the exchange traded scrip today swapping hands for $1.83 after floating at $2 per share in April of this year. As such investors are down around 9% in a couple of months on the back of  a mildly disappointing start.

Over the short term markets can easily move against the best investors in the same way as they can sometimes unduly exaggerate positive returns if everything falls into place regarding an investor’s timing.

As such it would pay not to place too much emphasis on L1’s recent falls, as it was always likely to struggle to maintain annualised returns of 36.4% without observing proper risk management practices.

Hedge funds or “long / short funds” can commonly generate a lot of their alpha via short bets paying off, but the effect can reverse if the short bets move against them.

L1 Capital has made no secret of the fact it has bet against Tesla shares in the past and the electric car company’s strong recent performance probably dented returns a little.

I’m also aware that the fund has successfully shorted private hospital operator Healthscope Ltd (ASX: HSO) in the past and its recent surge on the back of takeover bids may also have put a dent in L1’s early performance.

L1’s management team blamed the underperformance on the “recent surge” in growth stocks at the expense of value stocks that are favoured by the manager on the long side.

Foolish takeaway 

If I were an L1 Long Short Fund investor I wouldn’t be troubled by the early performance of the fund as it has a strong investment team in place and impressive track record. Management are also heavily invested in the funds themselves which is as good a sign as any that they will be working hard to ensure healthy long-term returns. Moreover, a 9% fall today could easily swing to a 9% gain by April 2019 in which case the initial falls would be long forgotten.

Buying investment funds can generate strong returns, but the really big gains come about if you can pick and buy the individual stocks yourself that might be tomorrow’s massive winners..

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Motley Fool contributor Tom Richardson has no position in any of the stocks mentioned.

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The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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