Dedicated Short Bias: A Hedge Fund Strategy Explained

What Is a Dedicated Short Bias?

Dedicated short bias is a hedge fund strategy that maintains a net short exposure to the market through a combination of short and long positions. A dedicated short bias investment strategy attempts to capture profits when the market declines by holding investments that are overall positioned to benefit when the market or investments decline.

Dedicated short bias funds will still maintain a hedge of sorts with long positions in some securities. This attempts to minimize losses when a bull market is in full force. However, they are designed to profit when a bear market sets in.

Understanding a Dedicated Short Bias

A dedicated short bias is a directional trading strategy that involves taking a net short position in the market. In other words, a larger proportion of the portfolio is dedicated to short positions rather than to long positions. Being net short is the opposite of being net long. Hedge funds that maintain a net long position are known as dedicated long bias funds.

Dedicated short bias ETFs include instruments such as ProShares UltraShort 20+ Year Treasury, Invesco DB US Dollar Index Bearish, Short Dow30 ProShares and so on. An investor should be able to tell from the name that a fund or ETF has a dedicated short bias.

From Shorting to a Short Bias

Prior to the long-term bull market for U.S. equities that took place in the 1980s and 1990s, many hedge funds used a dedicated short strategy, rather than a dedicated short bias strategy. The dedicated short strategy was one that exclusively took short positions. The dedicated short funds were virtually destroyed during the bull market, so the dedicated short bias fund emerged and took a more balanced approach. The long holdings are enough to keep losses manageable, although funds can still run into problems with leverage and capital flight if losses continue for too long.

The Challenge of Maintaining a Dedicated Short Bias

Committing to a bias, whether long or short, puts these hedge funds in a tight spot operationally. Even when a bull market has continued to gore a hedge fund for a long period of time, the fund manager must reposition again and again to establish the net short as the long positions grow in value. Of course, when the market eventually reverses, these dedicated short bias funds race ahead.

There are other hedge fund strategies that allow the fund manager to go long or short without having to worry about which way the bias is tilted. These hedge funds are not market neutral, but they allow positional shifting with the goal of maximizing profits regardless of the overall market direction. Interestingly enough, these long/short equity funds often have a dedicated long bias that emerges naturally over time.

That said, these more flexible arrangements will have difficulty matching the performance of a dedicated short bias fund when the market is in a prolonged decline because there will be a lag time in adjusting positions that short fund won't have to deal with.