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Have Long-Short Credit Funds Delivered?

Implementation challenges, poor performance, and high costs weigh heavily on this Morningstar Category.

In May, Morningstar spun out a small subset of non-traditional-bond funds that focus on corporate credit into a new long-short credit category (currently 21 funds totaling roughly $11 billion in assets). Long-short credit funds sound interesting in theory. Corporate credit markets are rife with inefficiency, and a long-short strategy that seeks to benefit from anomalies in the pricing of credit risk while minimizing exposure to broader credit and interest-rate market swings may sound enticing--especially in overvalued (2013) and volatile credit markets (2015).

In practice, though, the strategy has struggled to deliver, both for the hedge funds that have greater flexibility with which to execute it and the highly regulated open-end mutual funds that try to adapt it to structures that permit investors to redeem assets at any time of their choosing. The long-short credit Morningstar Category may be a newly assembled group, but we don't expect its popularity to take off anytime soon. Implementation challenges, poor performance, and high costs damage the group's overall appeal.