This is how I see ALF works - tell me if I am off with the fairies. I'll explain it with algebra sorry, its how I think. The concepts are not hard.
There are three important numbers published in the NTA report. There the long positions (call it L), the short positions (call it S) and the cash position (call it C).
The NTA is L+C-S. Now ALF makes income on their L, S and C. Through their expertise the make trading income on L and S if they pick the right stocks. They also receive dividends from L, pay dividends on S and receive interest in C. There are also transaction and management costs of course.
Now, how it works, that is the market position, depends on the values of L, C and S. The managers decisions on the makeup of these here greatly effect how ALF tracks the market indexes (market exposure).
When L>S (long positions greater than shorts) ALF is long on the market. But it is rarely long to the same degree as an ETF which only has L (no S or C). It is only the same as an ETF when S=C (i.e. when the short positions are covered by cash. So how long or how exposed is it?
When L>C+S, ALF is a geared investment in the market. In other words, your investment of $1 is actually buying more than a $1 of the market because the money from the short positions is being used to buy more of the market than the cash held.
When L
When L=S, ALF is market neutral like WMK. You are exposed to management's stock picking ability to the degree of cash held. You can look at this as a cash deposit if you think shorts and longs will balance each other.
When L
As an example, in the 28th February 2010 NTA report L=181M, C=-3M, S=70M. ALF was geared in the market to $4M (103%). It was a good bet in hindsight.
On 31st December 2014, L= 318, C=307 and S=298. ALF was almost market neutral with the long and short positions almost cancelling each other (6% long) (ALF publishes the percentage exposure to the index). Income from this position is largely due to the stock picking ability (long and short) and the interest earned on the cash. The index movements would be largely irrelevant and ALF would behave similar to WMK.
If you want an example of ALF being short the whole market look at March/April 2009.
The reason the above is harder to understand is that you have to consider the cash held as well as the short positions when working out if you are exposed to the overall stock market. ALF uses an index as a benchmark but in December 2014 they were hardly tracking it at all, they were relying on cash and stock picking (up and down).
Its also worth mentioning other "absolute return" funds like WAM you also have to consider C when working out how exposed to the market index moves they are (WAM has a small S). Also geared funds like ALR and DUI you may have negative C which represents the bank loans, good old fashion gearing. ALF is different because they mainly use the short positions as gearing and to control market exposure, 3 variables instead of WAM's two. A short position is an opportunity to profit from a good choice whereas a bank loan you know you are stuck with paying interest. They have been very good at this until recently.
Having said all that, I still think ALF is a good long term investment. They have had a bad run over the last few months. Like joewolf mentioned, if they are still having a bad run in six months then it will be time to reassess because something has changed. Until then I will buy if they drop to a NTA discount, which is another story completely.
This is my hobby so don't take me too seriously.
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