First Quadrant challenges convention on short-extension strategies
Nov 1st, 2007 | Filed under: 130/30, Guest PostsThere is obviously something in the water in California that has led to uncommonly large cerebral cortexes in some of its citizens. This is partly evidenced by the flood of financial innovation coming from the Left Coast for over a generation – from Barr Rosenberg to Bill Sharpe, BGI/Wells Fargo, Analytic, and Wilshire. Even Harry Markowitz loved the place so much, he recently conducted a presentation in Boston by satellite so he wouldn’t have to leave (see posting).
Today, we are pleased to bring you a guest posting from one of the homes of the large-brained Financialus Californius: Jia Ye of First Quadrant L.P. In this summary of a yet-to be-published First Quadrant white paper, Ye warns us that not all managers can benefit from removing the so-called short constraint. And what she has found may surprise you.
Do Short Extensions Benefit All Managers?
By Jia Ye, Director & Chief Investment Strategist, First Quadrant L.P., Special to AllAboutAlpha.com
Contrary to popular belief, the ability to take short positions in equity portfolios does not necessarily lead to superior performance for all managers. When we take into account the positive skew in stocks returns, only managers who can maintain a stable correlation between forecast and realized returns (captured by the manager’s information coefficient or IC) can take full advantage of the efficiency gains from short extensions. In other words, the ability to short stocks will not necessarily help managers with an unstable IC.
As the volume of articles here at AllAboutAlpha.com clearly illustrates, there has been a lot written recently about short extension (1X0/X0) strategies. But there is little mention, here and elsewhere, that studies of this topic are based on one or both of the following implicit assumptions:
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[…] An important caveat for investors looking to adopt short extension strategies. (All About Alpha) […]
Let me summarize this article without having to you having to read it. Investing is about buying stocks that go up and selling stocks that do down. This applies to long, long/short or 1X0/X0.
No NEW insights in this article or the corresponding paper.