Long-short funds in focus: Can SIFs generate alpha in a volatile market?

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Long–short funds and Specialised Investment Funds (SIFs) have emerged as one of the most talked-about product categories in India’s mutual fund industry. With equity markets entering a more volatile and uncertain phase, fund managers are evaluating whether these strategies can deliver alpha while managing risk more effectively than traditional long-only funds.

At a Moneycontrol discussion, Sandeep Tandon of Quant Mutual Fund, Gaurav Mehta of SBI Mutual Fund, and Bhavesh Jain of Edelweiss Mutual Fund shared how they are approaching long–short strategies, investor suitability, and the evolving role of SIFs in portfolio construction.

Shorting and the shift toward risk-adjusted returns

Sandeep Tandon said one of the key challenges for long–short strategies in India is investor perception. Shorting is commonly associated with hedging, while its potential role in alpha generation is not widely understood.

He noted that while hedge funds and family offices are familiar with using short positions to generate returns, this understanding is still limited among most investors. According to Tandon, SIFs represent a structural change, as they allow fund managers to focus on risk-adjusted returns, rather than only absolute or relative performance.

He added that in a market environment marked by geopolitical uncertainty and more complex bull phases, long–short strategies can offer better beta management, particularly during periods of consolidation or correction.

Addressing the arbitrage-hybrid gap

Gaurav Mehta said conventional mutual funds largely function as beta-driven products, where performance is closely tied to the direction of underlying asset classes. SIFs, by contrast, allow portfolios to benefit even during market declines and help address gaps that long-only products cannot.

He highlighted that changes in debt fund taxation have made it difficult for investors to find low-risk, tax-efficient return options. This has led to significant inflows into arbitrage funds, despite modest returns, while hybrid funds still present a meaningful jump in volatility for many investors.

To address this gap, SBI Mutual Fund launched a hybrid long–short fund aimed at delivering returns moderately higher than arbitrage with limited variability. The fund maintains 65–75 percent exposure to equities to qualify for equity taxation, with 25–35 percent allocated to debt, along with limited exposure to REITs and InvITs.

Mehta clarified that this equity exposure is actively risk-managed using derivatives such as covered calls and protective put options. As a result, while the fund remains correlated to market movements, its overall sensitivity to market volatility is kept low.

Early distribution challenges and adoption

Mehta said adoption of SIFs is still in early stages, partly due to the requirement that distributors clear a derivatives examination before selling these products. However, since the launch of SIF offerings, the number of registered distributors has increased, suggesting growing engagement from the distribution ecosystem.

An arbitrage plus strategy

Bhavesh Jain said Edelweiss Mutual Fund approached long–short strategies by building on its experience across arbitrage, balanced advantage, equity savings, and multi-asset funds. The firm positioned its SIF offering as an arbitrage-plus strategy, with a target of generating 2.5–3 percent returns above arbitrage without introducing significant additional risk.

Jain said the fund does not rely on directional market shorting. Instead, it uses option writing, higher flexibility in debt allocation, and special situations such as IPOs, mergers, and open offers—strategies that are restricted or unavailable in traditional arbitrage funds.

He added that early performance indicators show low portfolio beta and limited volatility, aligning with the fund’s objective of delivering stable, absolute-return-oriented outcomes.

Managing mid and small-cap beta

Tandon said that globally, long–short strategies are often used as wealth preservation tools, particularly in high-beta segments of the market. Quant Mutual Fund’s SMID-focused long–short strategy is designed to manage volatility in the mid- and small-cap space, where drawdowns can be sharp during market corrections.

He explained that the strategy allows selective shorting within the mid- and small-cap universe and does not require continuous short exposure. The fund can operate with full long exposure when market conditions are favourable. According to Tandon, the objective is to generate returns relative to mid- and small-cap benchmarks while reducing volatility and drawdowns during challenging market phases.

Investor suitability and tax efficiency

Tandon said long–short funds are positioned for investors seeking lower volatility and better downside protection rather than aggressive return maximisation. He added that combining long–short strategies with traditional mutual funds can help create portfolios with improved risk-adjusted outcomes.

Tax efficiency was highlighted as a key feature. Gains generated within SIFs are not taxed until redemption, regardless of trading activity within the portfolio, offering an advantage over direct trading strategies.

Education and measuring success

Mehta said investor and distributor education remains critical for the category’s growth. SEBI’s requirement for separate branding for SIFs and mandatory distributor certification helps differentiate these products from traditional mutual funds. Jain said performance evaluation will vary by strategy. In Edelweiss’s case, success is measured by consistency, the number of negative periods, and the ability to outperform the stated benchmark rather than short-term market movements.