For more than two years, U.S. equity market performance has been driven by an unusually small number of high-flying technology stocks known as the Magnificent Seven. One result of that lopsided performance has been the nearly unprecedented concentration risk the market now entails: The Magnificent Seven today make up almost 30% of the S&P 500 Index¹ (S&P 500) and more than half the Russell 1000 Growth Index.²

It’s no secret that this unusual level of concentration risk means a downturn in the tech sector or disappointing earnings results for just a handful of companies would have severe implications for investors, particularly those with allocations designed to track the S&P 500 or with growth-oriented positions. With large parts of the market looking fully valued to us, there isn’t a lot of opportunity in prices to absorb any bad news—and signs of trouble are already emerging.

The economic soft landing investors are hoping for may be bumpier than expected

President Donald Trump promised new rounds of tariffs if elected and, for better or worse, that moment has arrived. Tensions with trading partners have increased and retaliatory tariffs have been enacted, with the economic consequences hard to predict. The U.S. Federal Reserve (Fed), sensing renewed inflationary pressures since December, has paused its attempts to lower interest rates. Companies have recently been announcing layoffs at an accelerating pace, consumer confidence has continued to trend down, and GDP in this year’s first quarter contracted by 0.3%―the first decline since 2022.

If broad economic conditions continue to deteriorate—or even if they remain in their current state—it becomes increasingly hard to see how the stellar returns for the stock market over the past two years could repeat themselves for a third time in a row, in our assessment (the S&P 500 gained 26% in 2023 and 25% in 2024). Investors would be wise to ask themselves whether their portfolios are positioned to endure increased volatility in the markets, as that turbulence may have already returned to the market and could persist for some time.

Long/short investing can help in markets like these

While there are no guarantees when it comes to investing, maintaining a well-diversified portfolio as a general principle has rarely disappointed. One of the most foundational tactics when it comes to diversification is the idea of offsetting equity market risk by owning bonds. This time-tested strategy has much to recommend it, but it isn’t foolproof: Instead of one zigging while the other zags, stocks and bonds do occasionally move in the same direction. For example, in 2022, the S&P 500 was down just over 18%. The yield of the 10-year U.S. Treasury bond began that year at 1.63% but finished at 3.88%; the Bloomberg U.S. Aggregate Bond Index finished down 13%. The good news is that there are multiple ways to achieve the goal of portfolio ballast. We’d argue that one of the most effective (and underappreciated) ways of hedging against market downturns is through shorting stocks.

We’d argue that one of the most effective (and underappreciated) ways of hedging against market downturns is through shorting stocks.

By way of background, shorting a stock typically means borrowing a stock from an entity that already owns it, then selling the position based on the belief that it will be worth less in the future than it is today. If the stock does in fact depreciate, the borrower can buy it back and return the shares to the lender; the short seller’s profit is effectively the amount by which the stock declined.

Long/short strategies come in many different styles but, as a rule, they all combine long and short positions in a single portfolio. Some managers take a market-neutral approach, which aims for investor capital dedicated to the long and short portfolios to be equal; other managers use a variable long-biased approach, wherein the manager typically maintains a larger percentage of assets on the long side of the portfolio than the short portfolio.

In general, these types of strategies can generate a positive return in any of three ways: The long positions the portfolio holds can appreciate, long positions can outperform short positions, and the proceeds from the short sales can be reinvested and earn a positive return themselves.

What happens to the proceeds from short sales can vary greatly depending on the strategy. Some reinvest the capital into the highest-conviction long equity positions, effectively creating a form of leverage. Other strategies take a more conservative approach and invest the capital in high-quality short-term bonds, such as three-month Treasuries. In either case, the result is a portfolio that may benefit when the stock market goes up or down.

While ideally the securities a long/short strategy has shorted would go down in value (which, again, adds to total returns) while the long positions go up, it’s generally the case that a strategy will appreciate in value when its long holdings outperform its shorts.

In just about any environment, even a strong bull market, there are usually opportunities to identify securities that appear overvalued and due for a price correction, which is one key way shorting stocks can add value over time.

Higher interest rates can act as a tailwind for long/short strategies

Higher interest rates are generally good news for long/short strategies for several reasons. First, all else being equal, a higher cost of capital tends to mean that financial missteps have more significant consequences for companies: An environment with a greater dispersion of returns—bigger spreads between the winners and losers—means a broader opportunity set for short portfolios.

The other reason higher rates can be helpful is that the proceeds from short sales that are invested in Treasuries can earn a higher rate of return. This was decidedly not the case during much of the period from 2009 to 2022; for much of that time, short-term rates were generally close to zero.

Higher rates also create a bigger buffer for investments that don’t pan out quite as anticipated: When a stock is shorted but actually goes up in value by, say, 3%, and those proceeds earn 4% in short-term Treasuries, that trade still represents a profit.

With inflation still proving a challenge for the Fed to rein in to its desired level, short-term rates could remain elevated at or near their current levels for some time.

Using long/short strategies in a diversified portfolio

There are any number of ways to incorporate a long/short strategy into a diversified portfolio. Consider the typical 60/40 mix of stocks and bonds. For investors concerned about exposure to equities in the face of rising volatility, a portion of the equity sleeve could be reallocated to long/short strategies with the goal of reducing overall market exposure; a 50/40/10 mix might be one result. Conversely, investors looking for more upside potential than is typically available in high-quality fixed income might allocate some of their defensive budget to long/short strategies; think 60/30/10. For investors who already own a slug of alternatives—perhaps a 50/30/20 allocation—long/short strategies would be right at home within the dedicated alts sleeve.

Experience matters in uncertain markets

Long/short investing is a nuanced discipline and requires a different skill set than constructing a long-only portfolio. Companies facing headwinds or deteriorating fundamentals could be underweighted, avoided, sold, or shorted. Knowing which tactic to draw on and when is an ability we believe can only be gained through hands-on experience.

At Boston Partners, we’ve been managing dedicated long/short strategies for over 25 years in all kinds of markets—through crises, bubbles, rebounds, and turbulence. 

Ample opportunities exist—even in good years for the market—to add value through short positions

Individual stocks within the S&P 500 Index: number of positive and negative performers, and best and worst performance, by year

In our assessment, after two years of stellar performance in U.S. equities, new cracks are beginning to show in the foundation that’s supported such a rally. Fundamentals are less certain than ever given the shifting trade and tariff policies pursued by the Trump administration, and valuations by most metrics appear to be stretched to uncomfortably high levels, in our view. At Boston Partners, we believe long/short strategies were built for moments like this. With myriad varieties of long/short strategies available to investors and multiple ways to implement long/short into a diversified portfolio, we believe investors concerned about the downside risk in equities should be asking how―not whether―to work long/short strategies into their long-term allocations.

1 S&P Dow Jones Indices, as of 4/30/25. 2 FTSE Russell, as of 4/30/25.