First Trust Long/Short Equity ETF (FTLS)

“If you have no idea whether the market goes up or down, but you know which stocks are mispriced, you can still win.”

The First Trust Long/Short Equity ETF (FTLS) is built on that premise. It holds a portfolio of long positions (stocks the manager believes are undervalued and will rise) and short positions (stocks the manager believes are overvalued and will fall), aiming to profit from the relative mispricings rather than from the direction of the overall market. In theory, it should deliver returns that owe nothing to whether the broad market rallies or crashes.

The strategy in plain language

A long/short fund buys stocks it thinks are cheap and sells short stocks it thinks are expensive, typically in equal dollar amounts or balanced weights. When both bets work — the longs rally and the shorts fall — the fund wins twice. If the market crashes, the short positions gain value while the longs lose less than the market because they were undervalued to begin with. If the market soars, the longs surge while the shorts drag less because they were overvalued. The hoped-for result is a return profile almost uncorrelated with the market itself — a fund that makes money from stock-picking skill rather than from riding market momentum.

The appeal is obvious. A traditional long-only equity fund rises and falls with the market; a long/short fund can, in theory, make money in any market — bull, bear, or sideways — if the manager is skillful at identifying mispricings.

Why it works better in theory than practice

Long/short strategies have two structural challenges. The first is cost. Shorting stocks requires borrowing them, which incurs an interest cost (the borrow fee), and the manager typically collateralises the short positions at unfavourable rates. Those costs act as a constant drag on returns. A manager has to be genuinely skillful just to overcome the baseline friction of running the strategy.

The second is market regime. Long/short strategies fare best in choppy markets where good stock-pickers can identify mispriced gems. They struggle in strong bull markets where rising tides lift all boats — there is simply less mispricings to exploit because sentiment carries all stocks up together. In a decade like the 2010s when passive index investing surged and active managers uniformly underperformed, a long/short strategy had nowhere to hide.

The structural constraints

FTLS is technically an ETF, but it operates differently from a traditional equity ETF. It is actively managed — the portfolio is not tracking an index but is instead built by human discretion. That means FTLS is subject to the manager’s view of value, their stock-picking skill, and their ability to time short positions without being caught in a short squeeze when a stock suddenly surges.

The fund also faces daily liquidity pressures that index ETFs do not. Shares can be redeemed and created throughout the day, which forces the manager to hold enough cash or liquid securities to handle redemptions without disrupting the long/short positioning. That tie-up of capital is another headwind on returns.

Real risks and realistic expectations

The most dangerous risk is manager error. Stock-picking is hard; going short — betting that a stock will fall — is harder and higher risk because short losses are technically unlimited (a stock can only fall to zero, but it can rise forever). An overconfident short position in a momentum stock can blow up the fund. The prospectus details how the manager controls short risk, but that control is only as good as the execution.

A second risk is crowding. If many long/short managers are picking the same undervalued stocks to go long and the same expensive stocks to go short, they create a self-reinforcing feedback loop: their buying bids up the longs and their shorting drives down the shorts, creating temporary profits that eventually reverse when crowding unwinds and mispricings correct. Funds can work until they do not.

The third, brutal reality is alpha is not free. Most active managers underperform their benchmarks after fees over long periods. Long/short strategies impose even higher fees and friction than traditional active management, so a long/short fund has to beat its benchmark by a larger margin just to match a passive alternative. For investors, the question is not whether FTLS can beat the market; it is whether it can beat a combination of a broad equity ETF and a short-term bond fund — a simple alternative strategy that is cheaper and places no faith in manager skill.

How to evaluate and research

Start by comparing FTLS’s returns against the broader market (S&P 500 or Russell 2000 depending on which universe the fund targets) over rolling periods of one, three, five, and ten years. If the fund materially trails over most periods, it is not justifying its existence. Next, examine the long/short turnover: how often are positions churned? High turnover amplifies transaction costs and taxable gains. Look at the size and liquidity of short positions: does the fund short illiquid micro-caps (risky) or larger, liquid names (safer)? Check the manager’s actual record before this fund launched, if available, to assess whether the long/short track record is skill or luck. Finally, run a simple comparison: a 60/40 portfolio of a cheap broad equity ETF and a bond ETF likely carries lower fees and less complexity — would that simpler approach serve your goals as well?