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Aspects of Constrained Long-Short Equity Portfolios

Eric H. Sorensen, Jing Shi, Ronald Hua and Edward Qian
The Journal of Portfolio Management Winter 2007, 33 (2) 12-20; DOI: https://doi.org/10.3905/jpm.2007.674790
Eric H. Sorensen
The president and chief executive officer of PanAgora Asset Management in Boston.
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  • For correspondence: esorensen@panagora.com
Jing Shi
A senior lecturer in finance at the School of Finance and Applied Statistics of the Australian National University at the School of Finance of the Jiangxi University of Finance and Economics, China.
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  • For correspondence: Jing.Shi@anu.edu.au
Ronald Hua
The director, Dynamic Equity, at PanAgora Asset Management in Boston.
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  • For correspondence: rhua@panagora.com
Edward Qian
The director, Macro Strategies, at PanAgora Asset Management in Boston.
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  • For correspondence: eqian@panagora.com
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Abstract

Fiduciary institutions are forging ahead to remove the traditional long-only handcuffs that constrain the delivery of maximum net alpha by their equity managers. The proliferation of 130/30 managers (long 130% and short 30%, with beta 1.0) prompts a question as to the optimal ratio for these constrained long-short strategies. Analysis of the range from long-only to fully unconstrained will help find the optimal solution that maximizes the risk-adjusted return. The ratio that maximizes net information ratio (IR after leakages) depends largely on the risk budget, the chosen benchmark, leveraging costs, and the transaction costs associated with turnover. In the case of normal active risk (3%-5%), more alpha leverage is better than less. That is, despite the declining marginal benefit of higher leverage, 150/50 may be better than 120/20, approximating a pure market-neutral strategy.

TOPICS: Portfolio management/multi-asset allocation, portfolio construction, security analysis and valuation

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The Journal of Portfolio Management
Vol. 33, Issue 2
Winter 2007
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Aspects of Constrained Long-Short Equity Portfolios
Eric H. Sorensen, Jing Shi, Ronald Hua, Edward Qian
The Journal of Portfolio Management Jan 2007, 33 (2) 12-20; DOI: 10.3905/jpm.2007.674790

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Aspects of Constrained Long-Short Equity Portfolios
Eric H. Sorensen, Jing Shi, Ronald Hua, Edward Qian
The Journal of Portfolio Management Jan 2007, 33 (2) 12-20; DOI: 10.3905/jpm.2007.674790
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