Toward More Information-Efficient Portfolios

Abstract

The long-only constraint imposed in traditional portfolios is one of the more severe constraints in terms of its impact on potential value-added, particularly for portfolios benchmarked to a capitalization-weighted benchmark such as the S&P 500; it can reduce the effectiveness of the manager's information by 50% or more. This loss can be avoided to a great degree by eliminating the long-only constraint or by creating a market-neutral portfolio with a derivatives overlay to restore market exposure. The information ratio can also be increased considerably using only underlying securities by allowing modest short positions and using the cash generated to purchase an equivalent amount of long positions, thus maintaining full market exposure.