Risk and Portfolio Mechanics · Hedge Funds
Gross and net exposure answer different questions. Both are useful, and neither is a complete measure of potential loss.
Write the denominator and convention
For a simple equity portfolio, gross exposure adds the absolute long and short positions. Net exposure subtracts shorts from longs. Dividing by NAV expresses each as a percentage of investor capital. Cash, derivatives and hedges require explicit conventions so comparisons remain meaningful.
Suppose NAV is $100 million, long shares total $140 million and shorts total $60 million. Gross exposure is 200% and net exposure is 80%. Gross indicates the size of the books. Net suggests a directional imbalance in dollars, but does not adjust for different market sensitivities.
Leverage has several forms
Balance sheet leverage can compare assets with equity capital. Economic exposure can also arise through derivatives without an equivalent cash asset purchase. A futures contract’s notional, an option’s delta adjusted exposure and a bond’s duration measure describe different aspects of risk.
For example, $100 million of short maturity government bonds and $100 million of long maturity bonds have the same market value but different sensitivity to yields. Adding their notionals does not capture that difference. Likewise, a small option premium can represent a large nonlinear exposure.
Connect exposure with stress loss
If the illustrative long book falls 10% and the shorted shares fall 5%, the long loss is $14 million and the short price gain is $3 million. The combined loss is $11 million before costs, or 11% of initial NAV. A positive net exposure measure alone did not specify this exact outcome.
Ask how exposure reports treat offsets, derivatives, currencies and changing NAV. After losses, the same dollar position can represent a larger percentage of capital. Review risk limits together with financing needs and stress scenarios rather than ranking funds by one gross exposure number.
Try it yourself
A fund has NAV of $50 million, longs of $75 million and shorts of $25 million. What are gross and net exposure percentages?
Show the worked answer
Gross is $100 million divided by $50 million, or 200%. Net is $50 million divided by $50 million, or 100%. These are simple dollar measures before any sensitivity adjustment.
Further reading
Educational material, not a recommendation to buy or sell a fund. Numerical examples are hypothetical. Fund terms, investor eligibility and tax treatment vary by product, account and jurisdiction.
