An Empirical Analysis of 130/30 Strategies

Abstract

There is growing interest in the marketplace for enhanced active equity strategies as investors search for higher alpha in an era of lower expected returns. An enhanced active strategy partially removes the long-only constraint, allowing managers to short a portion of their portfolio to enhance active returns. Evidence of just how popular these strategies have become is apparent in the tremendous growth in assets over the last year. Investment industry periodicals estimate that assets in these strategies may be as high as $60 billion by mid 2007 and could reach $500 billion within five years. This article conducts an empirical analysis of 130/30 strategies, using an illustrative stock selection model. Results show that removing the long-only constraint can substantially enhance returns. Backtests of quantitatively-oriented strategies in domestic and international universes indicate that 130/30 strategies perform substantially better than long-only strategies with only modest increases in risk. A framework for attributing relative performance to the longs and shorts is also developed.

TOPICS: Security analysis and valuation, options, quantitative methods, global