Is 130/30 “optimal”? (Part 2 of 2)
Aug 2nd, 2007 | Filed under: 130/30In late June, Citigroup released a comprehensive 36 page quantitative analysis of 1X0/X0 strategies. Its lead author, London-based Citigroup MD Manolis Liodakis has written this summary exclusively for AllAboutAlpha.com. The summary has been divided into two postings. Today features the second of those postings.
Special to AllAboutAlpha.com by: Manolis Liodakis, PhD, Managing Director and Head of Global Quantitative Equity Research, Citigroup Investment Research
Yesterday, we described a generic model of a short extension strategy and established the notions of useful active weight or optimal leverage. Today, we discuss the various endogenous and exogenous variables that determine these metrics? First, the endogenous variables.
Tracking Error Target
Clearly tracking error is a very important factor in determining the optimal level of leverage for a particular fund. We carried out a series of simulations to study the effect of tracking error on the optimal level of leverage. Using data from 2006 we simulated 100 portfolio managers with equal levels of skill in picking winners and losers. They all had the same number of stocks on their buy and sell lists: 100 in each. The stocks on the buy lists and sell lists for each manager were chosen at random and were all different. The only constraint was that every fund manager should have the same level of skill; a hit rate of 55%. The chart below shows the distribution of optimal leverage levels across four tracking error scenarios:
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