Gross exposure is the fund's absolute level of investments. Gross exposure can be expressed in percentage or dollar terms and considers both the fund's short and long positions. Gross exposure measures total exposure to financial markets. It provides insight into how much risk investors are taking. Gross exposure is a measure of potential loss or gain.
Understanding Gross Exposure
In the context of institutional investors and hedge funds, gross exposure is a particularly relevant metric. These investors can be more sophisticated than the regular long-only investors and often have greater resources.
Hedge fund A, for example, has $200 million in the capital. It invests $150 million in long-term and $50 million in short-term positions. Its total exposure is therefore $150 million plus $50 million = $200 Million.
Gross exposure is equal to capital in this example. Therefore, it is 100%. Gross exposure above 100% means that the fund is using leverage. In other words, it is borrowing money to increase returns. Gross exposure lower than 100% means that a small portion of the portfolio has been invested in cash.
Comparison of Gross Exposure and Net Exposure
Net terms can be used to measure the exposure of investment funds. Net exposure is the sum of the long and short positions. For example, hedge fund A's net exposure is $100 million. This figure is calculated by subtracting $ 50 million, the capital held in short positions, and the $150 million in long holdings.
Net exposure equals gross exposure means that the fund has only long positions. If net exposure is zero, then the fund has no long positions. This is also known as market neutrality.
If a fund's net long exposure is greater than its short position, it has high net exposure. It also has a net long position if it holds more short positions than long positions.
Hedge fund B has $200 million in the capital, but it uses significant leverage. It has, therefore, $350 million in long and $150 million in short positions. This case's gross exposure is $500 million. The gross exposure, in this case, is, therefore, $500 million (i.e., $350 - $150 million).
Hedge fund B's gross exposure is a percentage of capital. It is $500 million/200 million = 250%. Fund B has higher gross exposure than A, which means it is more exposed to the markets. Leverage by Fund B will increase both losses and profits.
Take Note
Because it considers both the short and long side of investment decisions, gross exposure is used to calculate a fund's management fee. A fund's performance will be affected by the decisions made by portfolio managers and their distributions to investors.
A beta-adjusted exposure is another method for calculating exposure. This is also used in portfolios or investment funds. This is calculated by taking the average weighted exposure for a portfolio of investments. The beta of each security is used to determine the weight.
Net Exposure and Risk
A lower net exposure will reduce the chance that the portfolio is affected by market fluctuations. However, this risk depends on which sectors and markets the fund hold. The ideal situation is for a fund's short positions to appreciate and its long positions to decline in value. This allows both long and short positions to be closed at a profit.
The fund can still profit from its portfolio regardless of whether the short and long positions move together in the event of a broad market advance/decline, depending on its net exposure.
A net short fund, for example, should perform better in a downmarket because it has more short positions than long ones. The short positions may earn more than the long positions during a market downturn. The fund could lose if its long positions decrease in value and its short positions rise. This will depend again on its net exposure.
Example of Net Exposure
The fund's net exposure over time and its impact on returns can indicate the manager's commitment to the short-term and their expertise. Due to volatile stock market movements, hedge funds had a difficult year in 2018. According to a Goldman Sachs survey, most hedge funds managed to limit the damage and reduced their net exposure from 80% in Jan to 60% by November.
Gross exposures also declined due to a decrease in leverage to boost returns. Suvretta Capital Management kept its net exposure at half the level but reduced its gross exposure from 160% to 60% in Oct 2018. This indicated that it didn't wish to have too much debt, lest a market crash cause that debt to mushroom.
