Long-Short Funds Can Mitigate Your Portfolio Gyrations

Scott BuchananLeave a comment

Here we discuss some stock funds that go down less than stocks in general; the flip-side is that they go up less than plain stocks, as well. Some investors may appreciate the reduction in gyrations, especially after a week like the previous one.

Long-short funds come in two main flavors. When you buy a stock, that is considered being “long”. If you short-sell a stock (borrow shares from some broker, that you plan to pay market price for later, such that you make roughly one dollar for every dollar the stock goes down), that is being short.

 “Equity-neutral” funds are short as much value of stocks as they are long. So, they are net 0% long. Obviously, you would expect the value of such a fund to not decline much in a market crash. But conversely, it would not go up much in a bull market, either. So how is this better than just holding cash in your account? The magic is if the active fund managers can manage to be long a set of stocks which go up more than the stocks that they short. They often try to pair longs and shorts in the same sector. For instance, in 2024 if a fund was long Nvidia and short Intel (another stock in the semiconductor sector), that would have been a big net win. Sometimes this works, and sometimes it doesn’t.

The actual performance of such a fund is very dependent on the active managers’ skill and luck. For instance, here is a ten-year total return plot of two market-neutral funds, one from AQR and the other from Vanguard. The Vanguard fund (VMNIX) muddled along pretty flat from 2015 through 2021, then had a slow rise 2021-2023, then went flat again. The performance of the AQR fund (QMNNX) has been more erratic. It went up 2015-2017, then down a lot (this would have been hard to bear at the time, when the S&P was roaring upward) for 2018-2020. It then roughly matched the Vanguard fund for a couple of years, then pulled way ahead 2023-2025, as it made some great long/short choices:

However, the ten-year performance of these funds fell far short of a simple S&P500 holding (blue line above). Since stocks go up the vast majority of the time, a long-short fund which is net long seems to make more sense.

A plain vanilla net-long long-short fund is FTLS. It seems to be among the best of the long-short ETFs. It is usually about 60% net long. I modeled its performance against a portfolio of 60% S&P 500 stocks and 40% cash (rebalanced periodically), and it performed about the same. That is, FTLS went up and down with moves about 60% of what the S&P did. That is OK, but one might wonder why one would hold such a fund instead of just holding a 60/40 stocks/cash allocation for the same amount of investment. If we look at time periods with appreciable down periods, such as the past three years (see chart below), FTLS does look comforting; its muted dips in 2022 and 2025 compensate for its slower rise in 2023-2024, so it presents as a slow, fairly steady rise with a 3-year total return slightly higher than S&P. It is certainly easier psychologically to hold such a fund, and it might help small investors avoid the deadly mistake of panic-selling during a market downturn.

CLSE is a long-short fund that is often about 70% long. Management there takes a more swashbuckling, risk-taking approach. It went down less than S&P in the bear market of 2022 (as expected), and then it soared high above S&P in the first half of 2024, as it made skillful/lucky picks to go very long tech growth stocks like NVDA. That tech-heavy approach has backfired so far in 2025, since CLSE has fallen as much as S&P in the past several months (NOT what one hopes for a long-short fund). Despite that glitch, however, CLSE still weighs in with a 3-year return far ahead of the broader S&P (39% vs. 23%):

Another strategy to mitigate market ups and downs is for a stock fund to buy and sell put and call options, to create a “collar” effect. Buying puts limits the downward movements; the puts are financed by selling calls, which limits the upward swings. The fund ACIO, for instance, seeks to capture 65% of the S&P’s upside, while limiting loss to 50% of the downside.  In my stock charting, I found it ended up performing about like FTLS.  As of a week ago (Tue, Apr 8), the S&P was down 15% year to date (i.e., since Jan 1), while FTLS and ACIO were only down 8.3 % and 9.6%, respectively.

Standard Disclaimer: This is for information only. Nothing here is advice to buy or sell any security.

What I’ve been reading

mdmakowskyLeave a comment

In no particular order:

Caetano, Gregorio, and Vikram Maheshri. “Identifying dynamic spillovers of crime with a causal approach to model selection.” Quantitative Economics 9.1 (2018): 343-394.

The “broken windows” theory of crime (i.e small crimes lead to bigger crimes) continues continues to find very little support.

Cabral, Marika, and Marcus Dillender. Air pollution, wildfire smoke, and worker health. No. w32232. National Bureau of Economic Research, 2024.

Air quality remains an underrated public good.

McBride, Michael, and Garret Ridinger. “Beliefs also make social-norm preferences social.” Journal of Economic Behavior & Organization 191 (2021): 765-784.

It’s conditional cooperation all the way down.

Literature on Recent Advances in Applied Micro Methods

Your one-stop-shop for an updating list of the papers currently advancing causal identification in social science

Research on Big Questions April 2025

Joy Buchanan2 Comments

I’m working on a new paper with Bart Wilson. We might have a draft to release soon.

  1. https://economistwritingeveryday.com/2023/03/25/discrepancy-in-views-about-music-pirating/  In that post, I pointed out that the estimates reported in journals for the effect of pirating on music revenues range from almost 0% to almost 100%. There is room for new empirical work. Not often is the range of the estimates that big.
  2. My coauthor Bart Wilson did an interesting podcast episode for the Curious Task in 2020.

https://thecurioustask.podbean.com/e/ep-64-bart-wilson-%e2%80%94-is-the-idea-of-property-universal/

Episode: Bart Wilson — Is The Idea of Property Universal? 

I’m providing a rough transcription of the part that stood out to me, because he identified a prime big unanswered question. This is around minute 7 of the episode.

Host: Why is [the Property Species] an interesting topic deserving of a book?

Bart Wilson: “So, I work with primatologists… and I would talk to them about what I’m working on with my laboratory experiments on property. They would say, ‘Oh yeah. Dolphins do that, too, or baboons. … scrub jays re-cache their food if another scrub jay is watching them so they are protecting themselves against theft… so property is all over the animal kingdom. And then I’m also working with my colleague in the English department. In the humanities, property is a very narrow thing, something Western European. It’s very modern. And, so, in one part of the academy property is this broadly natural phenomenon and in another part of the academy it’s very local: only some humans have it. And so, as a social scientist…”

Bart identified a gap in understanding. Property cannot be both common to all animals and rare among humans. In his book The Property Species he spans that gap by claiming (spoiler alert) that property is common to all humans and only humans. Human language is an important piece of that story. No other animal can wield complex symbolic language.

In our new paper (manuscript forthcoming) we’ll be investigating how humans use symbolic language to describe nonrivalrous digital resources.

Old Fashioned Function Keys

Zachary Bartsch1 Comment

Your Function Keys Are Cooler Than You Think
by someone who used to press F1 by mistake

Ever notice the F keys on your keyboard? F1 through F12. Sitting at the top like unused shelf space. If you’re at a computer now, take a glance. I used to think they did nothing, or at least nothing for me. Maybe experts used them. Experts who know what BIOS and DOS are.  But for me, just little space fillers with no purpose. I frequently pressed F1 by accident rather than escape. A help window would pop up, wasting half a second of my life until I closed it.

But the Fn keys (function keys) are sneaky useful. They can save you serious time. No clicking. No dragging. No fumbling with touchpad mis-clicks.

When using a web browser, F5 refreshes the web page. Windows has added the same functionality for folders too, updating recently edited files. Fast and easy. F11 changes your web browser view to full screen. Great for long reads or historical documents. F12 shows the guts of a webpage. That’s perfect if you web scrape or need to know what things are called behind the scenes. Ctrl + F4 closes a tab. Alt + F4 shuts the whole application instance down. That last one works for almost all applications.

Excel? F4 saves so much of your life. It toggles absolute cell, row, and column references. Have you ever watched someone try to click on the right spot with their touchpad and manually press the ‘$’ sign… twice? I can feel myself slowly creeping toward death as my life wastes away. Whereas pressing F4 lets you get on with your life. F12 in most Microsoft applications is ‘Save As’. No need to find the floppy disk image on that small laptop screen. PowerPoint has its own tricks—F5 begins the presentation. Shift + F5 starts it from the current slide. Not bad. And don’t forget F7! That’s the spellcheck hotkey. But now it’s been expanded to include grammar, clarity, concision, and inclusivity.

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The Wild Market of July 8th, 2025

James Bailey4 Comments

April 2nd drove the point home- when someone in a position to know tells you something big is coming on a precise date, it is a smart time to act. As opposed to doing what I have done, which is think about acting but ultimately do nothing.

Ahead of April 2nd this year, the White House made a big deal of how they had a big announcement on trade coming April 2nd and I thought “this could go better or worse than markets expect, but some big move is coming, this seems like a great time to invest in volatility through something like VIX options expiring shortly after April 2nd”, but then I didn’t buy VIX options. I didn’t totally understand how they worked, didn’t want to buy without finding out, and didn’t make time to find out. My instinct was right though- the VIX more than doubled last week, so the right options on it much more than doubled. 

Ahead of the war in Ukraine in February 2022, US intelligence warned that Russia was planning to invade imminently, and I thought “they don’t have a great recent track record but it is very unusual for them to announce something so big will happen so soon, this is probably happening, this would be a good time to buy puts” but then didn’t buy puts, which of course did great as markets crashed following the invasion.

Yesterday the S&P 500 shot up 9% on the news that most of Trump’s new tariffs were paused. I thought this reaction was excessive given that the tariffs weren’t canceled, merely paused 90 days. Note that an exact date is being offered- July 8th! I sold some stocks last night and put in orders for S&P puts and VIX calls, but the limit options orders didn’t fill today as it seems the market caught up to my take from last night. The S&P is down 4% as I write this. This morning I was was researching which puts to buy, leaning toward SPY or XSP at-the-money puts for July 19 (first options date available after the 90-day tariff delay expires), then markets opened and their prices jumped 20+% in seconds as I watched. They are up over 50% now.

It is possible that the administration will fully clarify their stance on tariffs one way or another before July 8th, or even that Congress takes back their tariff power before then and makes their own deal. But I think it is more likely than not that we get a big announcement from the White House on July 8th about which tariffs will be implemented. In which case July 8th will be another wild market day.

This may already be priced in, but so far this April the situation has been changing so rapidly and touching so many parts of the markets and the real economy that even some of the most efficient markets (like US stock and bond markets) seem to be struggling to process what is happening. My ill-timed post from November praising the S&P has some lines that hold up well:

I’m now back up to 90% belief in efficient markets, at least for stocks.

This efficiency seems to change a lot over time. Probably fewer than 10% of US stocks have obvious mis-pricings right now; really none stand out as super mispriced to a casual observer like me. Instead, it seems like every 10 years or so a broad swathe of the market is driven crazy by a bubble or a crash, and you get lots of mispricing- like tech in 2000, forced/panic selling at the bottom in 2009, or meme stocks in 2021. The rest of the time, the stock market is quite efficient. So, in typical times, just be boring and buy and hold a broad index fund.

Ever since April 2nd, we have not been in typical times. At some point they will return and most people are probably best served by just holding through this (selling at the bottom and never getting back in is a big failure mode in investing). But for now the tariffs still have me thinking about buying VIX calls and stock puts (especially when policy changes loom on certain dates like July 8th), and on the bigger question of finding the sort of investments that did well in the 1970’s, another decade of stagflation that was kicked off by a President who broke America’s commitment to an international monetary system that he thought no longer served us.

Other “I, Pencils”

Jeremy Horpedahl2 Comments

When the owner of X.com, also the wealthiest man in the world, posted a video of Milton Friedman explaining how a pencil is made, many economists knew exactly where that reference came from: Leonard Read’s classic essay “I, Pencil.”

If you have never read “I, Pencil,” or if it has been a while since you last did, I encourage you to read it right now. It’s quite short and easy to read, as well as easy to understand. That’s what makes it a classic. But let me also summarize what I think are the two main points:

  1. No one can make a pencil on their own — it takes thousands of people to produce all of the inputs and assemble them into a simple pencil
  2. The activities of all those thousands of people are coordinated through subtle but miraculous social institutions, such as the price system, international trade, and property rights — rather than by force through government dictate, and even mostly outside of private firms (though firms are often part of the story)

Leonard Read communicated those ideas beautifully in an essay that is, somewhat humorously, written from the perspective of the pencil itself. But many other economists and economic communicators used other examples of goods to discuss similar themes. I’ll list a few of my favorites, but please comment with yours as well. Some of these essays and videos focus more on the production of the good, some focus more on the institutions, and not all are necessarily about international trade. But these “Other I, Pencils” are great introductory readings to remind us of the power of voluntary human cooperation.

Adam Smith’s “woolen coat” — this is a short discussion early in the Wealth of Nations, describing all of the people and trade needed to produce a woolen coat for a day laborer (at the link you’ll also see a comic version of the tale).

Harriet Martineau’s “plum pudding” — Martineau was a 19th century writer that popularized many of the ideas in Adam Smith. Less well known today, her discussion of international trade needed to bring many simple foods to our table, including plum pudding, is many ways superior to Smith’s discussion (start reading at the line “You mean machines”).

Thomas Thwaites “Toaster Project” — a book and Ted Talk explaining how to make a toaster from scratch — and fail miserably despite spending over $1,000 and spending hundreds of hours, all for something you can buy for a few dollars at the store.

Russ Roberts’ “It’s a Wonderful Loaf” — a poem set to video, explaining how a simple loaf of bread is always ready for you at the bakery when you want it in the morning.

T-Shirts — many examples!

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If Tariffs Are So Bad, Why Are They So Common?

Scott Buchanan4 Comments

Upfront disclaimer: This post is NOT about the most recent salvo of U.S. tariffs – enough apoplectic digital ink is gushing there already. It is about is an underlying question that these tariffs raised in my mind, which is the title of this article.

If there is one thing that nearly all economists, left, right, and center, can agree on, it is that free trade is good (see, for instance, a classic exposition of gains from trade on EcoNomNomNomics) and thus tariffs are bad. The main reason the local producers would need “protection” is because their goods (and services) are more expensive than the imports, and so by definition the consumers will pay more for their stuff. Thus, as is always noted, tariffs are a kind of tax on consumers. And yet…as far as I can tell all or nearly all nations impose tariffs on imported goods. So, what’s up with that?

This is not an area of expertise for me, so I went roaming the web to get some various opinions. The main reason given is to “protect local industry/agriculture”, and by extension, local jobs. We have to drill down deeper to see the reasoning involved.

In some cases, it is a simple, unsavory matter of a local industry having a powerful enough clout either at the business level or the labor level to lobby for special treatment (which costs the rest of the consumers more). But there are other cases where it is argued that it is important for national security to maintain a certain level of domestic production. For instance, historically nations like Japan and Switzerland maintained high tariffs on certain agricultural imports, in order to retain some domestic food production so they would not starve if something happened to interrupt international trade. Ditto for defense-related or other “strategic” production, and so on.

And in many cases, there just seems to be a gut feel that it is more patriotic or economically healthy to promote in-country production. Also, if a certain inefficient industry employs a lot of workers, the medium-term pain of letting that industry fail while resources shift elsewhere may be unacceptable. Economists promise us that the sooner or later those unemployed workers and empty factories will be put to some other, more worthy use, but it can be hard to believe in the “invisible hand” when suddenly you cannot pay your rent and no other jobs are available.

Two other factors came up. One is that for less developed counties without sophisticated internal revenue services, tariffs are a convenient way to collect revenue, and in fact may provide a significant share of government support. If I recall my high school history correctly, the fledgling United States government supported itself largely by tariffs, back in the day.

Another motive is what I would call “smart” tariffs, aimed not at indefinitely protecting inefficient producers, but at promoting improved production. What I have in mind is something I read some years ago, in an article I cannot now lay hands on, describing Korea’s path to industrialization. Protectionism was very much a part of that. The nation’s consumers did forgo short-term cheap consumption, in exchange for the development of domestic production which would in the long-term benefit everyone. I think one example was cigarettes. The government decided that cigarette production was a reasonable place to start industrializing, so they taxed imports to drive the price high enough to justify putting in cigarette-making equipment. After some years, they were happily making cigarettes, employing Koreans and building institutional muscle for the next phases of industrialization.

China has maintained a high degree of protectionism, including capital controls, and has grown and prospered mightily. So, I think that in assessing tariffs, it is essential to look past the immediate effects (which economists can always argue are “bad”, i.e., reduced consumption) to the longer-term impacts. Smart tariffs of the kind that East Asian countries have employed seem to have parlayed short-term consumer pain into long-term societal gains. Non-smart tariffs – -maybe not so much.

We did this to ourselves

mdmakowsky1 Comment

What, you think I’m going to pretend anyone is paying attention to anything but the trainwreck on Wall Street? As of 10:15AM this morning, the market is down 8% in 5 days, almost 20% off it’s peak, and is still falling. It’s entirely attributable to a unfathomably stupid trade war that has been forecast for months, if not years. This is the kind of probabalistic event that is usually internalized within the market in advance, which suggests that either very few people thought Trump a) was telling the truth, b) would be able to execute, or c) other forces within government would be able to stop him.

The legislative branch has largely ceded power to the executive, with only the judicial hanging on as some check against power. The open question, then, is at what level of damage will the legislative branch find incentive to reassert itself against an executive that (probably) doesn’t have the constraint of a future electoral victory to pursue? Will the destruction of great swaths of the US and global economy warrant reclaiming of power or impeachment of an executive?

I’m not optimistic.

When Genius Failed

James Bailey2 Comments

Myron Scholes was on top of the world in 1997, having won the Nobel Prize in economics that year for his work in financial economics, work that he had applied in the real world in a wildly successful hedge fund, Long Term Capital Management. But just one year later, LTCM was saved from collapse only by a last-minute bailout that wiped out his equity (along with that of the other partners of the fund) and cast doubt on the value of his academic work.

Roger Lowenstein told the story of LTCM in his 2001 book “When Genius Failed“. I finally got around to reading this classic of the genre this year, and I’d say it is still well worth picking up. The story is well-told, and the lessons are timeless-

  • Beware hubris
  • Beware leverage
  • Bigger positions are harder to get out of (especially once everyone knows you are in trouble)
  • In a crisis, all correlations go to one
  • Past results don’t necessarily predict future performance
  • Sometimes things happen that are very different from anything that happened in your backtest window.

The book came out in 2001 but it presages the 07 financial crisis well- not about mortgage derivatives specifically, but the dangers of derivatives, leverage, using derivatives to avoid regulations restricting leverage, and over-relying on mathematical models of risk based on past behavior. If Fed had let LTCM fail, could we have avoided the next crisis? Perhaps so, as their counterparties (most major Wall Street banks) who got burned would have been more careful about the leverage and derivatives used by themselves and their counterparties, and regulators may have taken stronger stances on the same issues.

Perhaps some more recent well-contained blowups foreshadow the next big crisis in the same way, like FTX or SVB?

Some more specific highlights about LTCM:

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Join Joy to discuss Artificial Intelligence in May 2025

Joy Buchanan1 Comment

Podcasts are emerging as one of the key mediums for getting expert timely opinions and news about artificial intelligence. For example, EconTalk (Russ Roberts) has featured some of the most famous voices in AI discourse:

EconTalk: Eliezer Yudkowsky on the Dangers of AI (2023)

EconTalk: Marc Andreessen on Why AI Will Save the World 

EconTalk: Reid Hoffman on Why AI Is Good for Humans

If you would like to engage in a discussion about these topics in May, please sign up for the session I am leading. It is free, but you do need to sign up for the Liberty Fund Portal.

The event consists of two weeks when you can do a discussion board style conversation asynchronously with other interested listeners and readers. Lastly, there is a zoom meeting to bring everyone together on May 21. You don’t have to do all three of the parts.

Further description for those who are interested:

Timeless: Artificial Intelligence: Doom or Bloom?

with Joy Buchanan

Time: May 5-9, 2025 and May 12-16, 2025

How will humans succeed (or survive) in the Age of AI? 

Russ Roberts brought the world’s leading thinkers about artificial intelligence to the EconTalk audience and was early to the trend. He hosted Nick Bostrom on Superintelligence in 2014, more than a decade before the world was shocked into thinking harder about AI after meeting ChatGPT. 

We will discuss the future of humanity by revisiting or discovering some of Robert’s best EconTalk podcasts on this topic and reading complementary texts. Participants can join in for part or all of the series. 

Week 1: May 5-9, 2025

An asynchronous discussion, with an emphasis on possible negative outcomes from AI, such as unemployment, social disengagement, and existential risk. Participants will be invited to suggest special topics for a separate session that will be held on Zoom on May 21, 2025, 2:00-3:30 pm EDT. 

Required Readings: EconTalk: Eliezer Yudkowsky on the Dangers of AI (2023)

EconTalk: Erik Hoel on the Threat to Humanity from AI (2023) with an EconTalk Extra Who’s Afraid of Artificial Intelligence? by Joy Buchanan

“Trurl’s Electronic Bard” (1965) by Stanisław Lem. 

In this prescient short story, a scientist builds a poetry-writing machine. Sound familiar? (If anyone participated in the Life and Fate reading club with Russ and Tyler, there are parallels between Lem’s work and Vasily Grossman’s “Life and Fate” (1959), as both emerged from Eastern European intellectual traditions during the Cold War.)

Optional Readings: “Technological Singularity” by Vernor Vinge. Field Robotics Center, Carnegie Mellon U., 1993.

“‘I am Bing, and I Am Evil’: Microsoft’s new AI really does herald a global threat” by Erik Hoel. The Intrinsic Perspective Substack, February 16, 2023.

“Situational Awareness” (2024) by Leopold Aschenbrenner 

Week 2: May 12-16, 2025

An asynchronous discussion, emphasizing the promise of AI as the next technological breakthrough that will make us richer.
Required Readings: EconTalk: Marc Andreessen on Why AI Will Save the World 

EconTalk: Reid Hoffman on Why AI Is Good for Humans

Optional Readings: EconTalk: Tyler Cowen on the Risks and Impact of Artificial Intelligence (2023)

“ChatGPT Hallucinates Nonexistent Citations: Evidence from Economics” (2024) 

Joy Buchanan with Stephen Hill and Olga Shapoval. The American Economist, 69(1), 80-87.

What the Superintelligence can do for us (Joy Buchanan, 2024)

Dwarkesh Podcast “Tyler Cowen – Hayek, Keynes, & Smith on AI, Animal Spirits, Anarchy, & Growth”

Week 3: May 21, 2025, 2:00-3:30 pm EDT (Zoom meeting)
Pre-registration is required, and we ask you to register only if you can be present for the entire session. Readings are available online. We will get to talk in the same zoom room!

Required Readings: Great Antidote podcast with Katherine Mangu-Ward on AI: Reality, Concerns, and Optimism

Additional readings will be added based partially on previous sessions’ participants’ suggestions

Optional Readings: Rediscovering David Hume’s Wisdom in the Age of AI (Joy Buchanan, EconLog, 2024)

“Professor tailored AI tutor to physics course. Engagement doubled” The Harvard Gazette. 2024. 

Please email Joy if you have any trouble signing up for the virtual event.