Hedge fund net vs. gross exposures

wjtmxlstlqkf's picture
Rank: Baboon | 159

I am having a hard time understanding the difference b/w net and gross exposures for long short equity funds.

Mathematically, net exposure is Long Percentage - Short Precentage.

Gross exposure is Long Percentage + Short Percentage.

I read Investopedia and other sources and some sources say that both net and gross exposures measure market risk. Other sources say that net exposure does not measure market risk but only gross exposure does. Which one is correct? Can someone please explain the difference between the two concepts in a simple example please?

Thank you very much

Comments (16)

Mar 11, 2018

Sure - they are both different measures of risk. As you said, gross exposure is long + short. If your gross exposure is exposure is over 100%, then that means you are using some sort of leverage/margin. If your gross exposure is less than 100%, then you are keeping a portion of your portfolio in cash. There is inherently more risk the higher your gross exposure is. Net exposure, as you said, is long - short. If your net exposure = gross exposure, then you only have long positions and your portfolio in theory will move in lock step with the market (excluding alpha you generate). If your net exposure is 0%, then your portfolio generally only moves when you generate alpha. Some tangible examples:

S&P500 ETF: you can think of this as a vanilla 100% gross exposure and 100% net exposure portfolio. There's no leverage, and it's long only.

Multi-Manager Hedgefund (Citadel / Point72 / Millenium / Balyasny): these guys generally run >400-500% gross exposure and net exposure close to 0%. Relative to an S&P500 ETF, you are taking on a different type of risk. High leverage means any change in value is amplified (i.e. a 10% move on a 500% gross exposure portfolio translates into a 50% move relative to the underlying equity assets you have from LPs). On the flip side, if the market tanks say 20% during a recession then in theory this would have no effect on a 0% net exposure portfolio (excluding alpha).

Finance bro's personal portfolio: most of us keep some savings in cash and some savings invested (most probably aren't shorting stocks with the PA) so this is probably say ~50-75% gross exposure with the net exposure being equal to the gross.

Hope this helps.

    • 3
Mar 12, 2018

Thank you !!

Mar 12, 2018

Thank you very much, but I still do not really get the intuitive interpretation behind net and gross exposures. How do they mean as they relate to the overall market movement? If the S&P 500 increases by 10%, what impact would it have a fund with X% and Y% of net and gross exposures respectively?

Mar 12, 2018

only net exposure measures exposure to market moves. So if you're 50% net long either by:

1 - 50% S&P 500 and 50% cash for 50% net 50% gross OR

2 - 250% long the s&P and 200% short something very similar to the S&P (let's say the dow jones) for 50% net but 450% gross

in both scenarios if the S&P (and dow) goes up 10% you'll make 5% on your portfolio. 1 = 10% * 50%. 2=(10%250%) - (10%200%).

so your net is what measures you against the market.

However, in this simple example, if for some reason the S&P went up 10% but the dow went up 20%, even though the "net" exposure to stocks is the same, portfolio 1 is still up 5% but portfolio 2 is now DOWN -15%. So the higher gross has much higher overall risk because your longs and shorts don't necessarily behave the same way, even though the pure "exposure" to a stock market can be the same. Multiply this gross exposure example over thousands of stocks, long and short, and you can see why you need BOTH net and gross to understand the risk of a stock portfolio (among many other things).

    • 3
Mar 16, 2018

Put another way:
Net exposure = Market (systematic) risk
Gross exposure = Single-stock (idiosyncratic) risk

All else being equal - the higher/lower return dispersion is across stocks, the more important gross/net exposure is.

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Mar 18, 2018

gross exposure is a thing because long and short risks are not symmetrical

if you are (at current market prices)
long 100 million dollars worth of Google stock
short 100 million dollars worth of facebook stock

The most you can lose on your long Google stock is 100 million dollars.
However, if you wake up one morning, and your short facebook stock has MORE THAN DOUBLED...then you can lose more than you initially invested...because by definition, a short position is always leveraged (because you sold stock that you didn't own...you borrowed it for the term of your short position).

So, Net exposure is an attempt to measure your risk to a parallel move in market prices across an asset class. Gross exposure is an "attempt" to measure total risk in non-parallel market moves. However, since short position have no theoretical loss limit, at the minimum, your broker can request 100% market value of margin to be deposited to hold a short (since you can wake up one morning and be down an infinite amount of money if a single asset reprices higher due to unforeseen news events). For many "hard to borrow securities" this is indeed the case. So, gross exposure is an attempt to put a number on what is really not a directly measurable risk.

just google it...you're welcome

Mar 18, 2018

Both measure market risk. Gross exposure is basically a measure of how much cash you have on hand. Net exposure is a measure of how long vs. how short you are.

If I have 110% long and 70% short, my gross exposure is 180% and my net exposure is 40%.

Note: You can have a long exposure > 100% because when you're short you get cash up front - sort've like debt in a way

Mar 18, 2018

Thank you very much, but I still do not really get the intuitive interpretation behind net and gross exposures. How do they mean as they relate to the overall market movement? If the S&P 500 increases by 10%, what impact would it have a fund with X% and Y% of net and gross exposures respectively?

Mar 18, 2018

That statement only works with net exposure, as it reflects net length. So when you're 130% long the s&p and 30% short, you move same as the market. Ofc most simplified. This same logic does't work with gross exposure as it doesn't distinguish shorts and longs.

Aug 29, 2019

On a related note. I am having a hard time understanding the hedge logic.

Say you have generated a trading idea and decided to be long 50% and 25% short, the net exposure will be 25%. Why not just be 25% long in the first place?

I understand that you have a separate idea, which would back the short position in another instrument or stock. But if the sole purpose of the short position is to hedge the long position, won't just decreasing the long exposure create the same result?

Aug 29, 2019

Short leg improves risk adjusted return (in theory)

Aug 30, 2019