Long–short strategies were once available only through hedge funds with high minimums and multi-year lockups. Today, a new class of long–short ETFs gives investors access to similar techniques — long positions in attractive assets and short positions in unattractive ones — all in a liquid, low-minimum, exchange-traded wrapper.

These ETFs aim to reduce downside risk, smooth returns, and provide diversification beyond traditional long-only equities.
This article explains how long–short ETFs operate, what types exist, and how investors can use them effectively.

1. What Is a Long–Short ETF?

A long–short ETF is an exchange-traded fund that:

• Buys (“goes long”) securities expected to rise in value
• Sells short (“goes short”) securities expected to fall in value

The goal is to generate positive returns from both sides of the market while reducing exposure to broad market swings.

Unlike traditional ETFs, which only hold long positions, long–short ETFs use a combination of:

• Long positions
• Short positions
• Derivatives (options, futures, swaps)
• Factor screens
• Quantitative models

…to create a portfolio with controlled net exposure.

2. Why Long–Short ETFs Exist

Long–short strategies solve a problem traditional long-only funds cannot:

They provide access to “pure alpha.”

By hedging or neutralizing market beta, long–short ETFs aim to capture manager skill (security selection, factor timing) instead of simply riding the market.

Key reasons for their popularity:

• Hedge-fund strategies at lower cost
• Daily liquidity
• Transparency
• No accreditation requirements
• Portfolio diversification
• Potential for lower volatility
• Potential for positive returns in down markets

They are one of the most accessible ways for everyday investors to implement hedge-fund-style thinking.

3. Types of Long–Short ETFs

Long–short ETFs vary significantly by strategy. Here are the most common categories:

A. Equity Long–Short ETFs

These ETFs take long positions in stocks expected to outperform and short positions in those expected to underperform.

They may use:

• Fundamental analysis
• Factor tilts (value, momentum, quality, low-volatility)
• Quantitative scoring systems

Goal: Better risk-adjusted returns than the market, with reduced drawdowns.

B. Market-Neutral ETFs

These aim for zero net exposure to the stock market.

Example structure:

• 100% long equities
• 100% short equities

Result:
Market movements cancel out, leaving only the alpha from stock selection.

These ETFs appeal to investors seeking uncorrelated or low-volatility returns.

C. Factor Long–Short ETFs

These ETFs create pair trades between factors:

• Long value, short growth
• Long quality, short junk
• Long high-momentum, short low-momentum
• Long low-volatility, short high-volatility

These strategies allow investors to express factor views without broad market exposure.

D. Sector-Rotation or Thematic Long–Short ETFs

These ETFs overweight sectors expected to outperform and short sectors expected to lag.

Examples:

• Long technology, short financials
• Long renewable energy, short fossil fuel companies
• Long defense stocks, short consumer discretionary

They behave more like tactical macro strategies.

E. Multi-Asset or Derivative-Driven Long–Short ETFs

These use futures, options, swaps, and global exposures to build sophisticated long–short portfolios across:

• Bond markets
• Commodities
• Currencies
• Volatility markets

Often these ETFs approximate systematic hedge-fund strategies (e.g., managed futures).

4. How Long–Short ETFs Construct Portfolios

While each ETF uses a different approach, most long–short ETFs follow this structure:

1. Screen and rank securities

Based on factors such as:

• Momentum
• Valuation
• Earnings quality
• Growth
• Analyst revisions
• Volatility

2. Build the long portfolio

Select the top-ranked securities.

3. Build the short portfolio

Select the lowest-ranked securities.

4. Set net exposure

This determines how sensitive the ETF is to the overall market.

Examples:

• Market-neutral: 0% net
• Conservative long–short: 20–40% net long
• Aggressive long–short: 60–80% net long

5. Apply risk controls

Through:

• Sector balancing
• Maximum position limits
• Liquidity filters
• Shorting constraints

The result is a portfolio aiming for alpha generation with controlled market risk.

5. Advantages of Long–Short ETFs

1. Diversification

They behave differently from traditional equity ETFs.

2. Downside Protection

Short positions reduce equity drawdowns.

3. Exposure to Hedge-Fund Strategies

Without the high minimums, lockups, or 2/20 fees.

4. Low Cost Relative to Hedge Funds

Expense ratios typically range from 0.45% to 1.2%.

5. High Liquidity

You can enter or exit the strategy anytime the market is open.

6. Transparency

Most long–short ETFs disclose holdings regularly.

7. Tax Efficiency

Especially compared to hedge funds with high turnover.

6. Limitations of Long–Short ETFs

1. Strategy Constraints

Regulations limit:

• Use of leverage
• Concentration
• Derivatives exposure

This can reduce return potential vs. private hedge funds.

2. Shorting Costs and Tracking Error

Borrow fees and imperfect hedges can drag performance.

3. Underperformance During Strong Bull Markets

Market hedges reduce upside capture.

4. Fees Are Higher Than Traditional Market ETFs

Though lower than hedge funds, long–short ETFs cost more than broad index ETFs.

5. Not All Strategies Translate Well to an ETF Wrapper

Some hedge-fund strategies rely on:

• Illiquid securities
• High leverage
• Complex derivatives
  These can’t be easily replicated.

7. When Investors Should Use Long–Short ETFs

1. To reduce portfolio volatility

A 10–30% allocation can smooth returns.

2. To hedge equity exposure

Market-neutral ETFs are particularly useful.

3. To diversify away from traditional beta

Long–short ETFs often have low correlation to stocks.

4. To express factor or sector views

Factor long–short ETFs provide efficient exposure.

5. To add systematic, rules-based alpha potential

Quant-driven long–short strategies can complement active stock pickers.

8. When Investors Should Avoid or Limit Long–Short ETFs

Avoid them if:

• You want pure equity upside
• You dislike complex strategies
• You prefer very low fees
• You need guaranteed liquidity during market stress

Limit exposure if:

• You don’t understand the strategy’s factor model
• You rely heavily on market beta for compounding
• You are sensitive to tracking deviations

Final Takeaway

Long–short ETFs bring hedge-fund logic into a liquid, transparent, accessible format. They allow investors to:

• Reduce market risk
• Gain exposure to alpha-focused strategies
• Improve diversification
• Implement tactical views
• Hedge a portfolio
• Access historically sophisticated techniques

While not a perfect substitute for private hedge funds, long–short ETFs offer one of the most practical, cost-effective ways for everyday investors to incorporate alternative intelligence into their investment strategy.