Reading 31: Equity Portfolio Management－LOS m

Long-short strategies can buy undervalued stocks and short overvalued stocks, earning two alphas. A long-only strategy can only earn the long alpha. Long-short strategies can eliminate expected systematic risk by buying one stock and shorting another in the same industry. The investor however still has unsystematic risk if the short position rises while the long falls.

Long-only strategies are focused on using fundamental analysis to find undervalued stocks. In contrast, long-short strategies focus on exploiting the constraints many investors face. For example, institutions are unable to short a stock. If an investor would like to express a negative view of an index security in a long-only strategy, he is limited to avoidance of the stock. The distribution of potential active weights in a long-only portfolio is asymmetric. A long-short investor can create a symmetric distribution of active weights by taking either long or short positions.

Although there may be limitations on short sales, they are not prohibited by securities exchanges. There are more potential buyers than sellers of stock so analysts are reluctant to lose these potential customers with a sell recommendation. Also management may hold their firms stock and options and put pressure on analysts to not issue sell recommendations.

Both managers are exhibiting style drift. Manager As drift is actually beneficial to performance while Bs is not. Value managers tend to have greater representation in the utility and financial industries whereas growth managers tend to have higher weights in the technology and health care industries. Growth stocks are more likely to outperform during a recession as there are few other firms with growth prospects and a premium would be placed on growth stocks valuation.