Kithara Long-Short Fund runs Rs 105 crore of longs with an average beta of 1.1 and Rs 95 crore of shorts with an average beta of 1.3, on Rs 100 crore of capital. What are its gross, net and beta-adjusted net exposures, and what happens if the market falls 10%?

Gross exposure is 200%, net exposure is plus 10%, but beta-adjusted net exposure is about minus 8%, so a 10% market fall makes the fund roughly 0.8%. The shorts are smaller than the longs in rupees but move more with the market. Calling the fund modestly net long is right in rupees and wrong in risk. To make it market neutral, cut about Rs 6.2 crore of shorts or add about Rs 7.3 crore of longs.

Gross exposure adds both sides: 105 plus 95 is Rs 200 crore, 200% of capital, a measure of how much is at work and how much can go wrong stock by stock. Net exposure subtracts them: 105 minus 95 is plus Rs 10 crore, 10% of capital. Net exposure in rupees treats every rupee as equally sensitive to the market, which is only true if longs and shorts share the same beta. On a seesaw a lighter child sitting further from the pivot can outweigh a heavier one sitting close in. Rupees are the weight; betaHow much a stock tends to move for each 1% move in the market. A beta of 1.3 means about 1.3% for every 1%. is the distance from the pivot.

Multiply each side by its beta. The longs carry 105 x 1.1 = Rs 115.5 crore of market exposure; the shorts carry 95 x 1.3 = Rs 123.5 crore. Beta-adjusted, Kithara is Rs 8 crore net short, about minus 8% of capital, even though it is 10% net long in rupees. When the market falls 10%, the longs lose about Rs 11.55 crore and the shorts gain about Rs 12.35 crore, so the fund makes Rs 0.80 crore before any stock picking. When the market rises 10%, it loses the same amount.

Close the Rs 8 crore beta gap from either side. Cutting shorts by 8 / 1.3, about Rs 6.15 crore, leaves Rs 88.85 crore of shorts carrying Rs 115.5 crore of beta, matching the longs. Adding Rs 7.27 crore of longs at a beta of 1.1 does the same from the other side. A beta-neutral Kithara would then look about 16% net long in rupees, which is why a fund's rupee net number, read alone, can mislead an investor in either direction. Which side to adjust depends on where the better ideas are, not on the arithmetic.

Say the limits. Betas are estimated from past prices and drift; the small cyclical names on the short side often behave very differently in a sharp sell-off, when correlations rise and betas bunch together. Beta-adjusted net is a better single number than rupee net, but it is still one number, and a book can be beta-neutral while carrying large bets on size, sector or momentum. A risk manager would check those factor exposures next.