A Question on Short Extension Strategy (from Equity Portfolio Management)

CFA Level III Equities
#1

Hi guys, I have a question when I am reviewing the short extension strategy under Equity portfolio Management section.

I was using _ Scheweser _ notes so quoted the paragraph as below:

" The short-extension strategy is a more efficient and coordinated portfolio of long and short positions. Long positions are only taken in under-valued (or at least neutral-value) stocks and short positions are in over-valued stocks. in contrast, a seperate 100/0 plus 20/20 strategy would first invest 100% of capital in the market portfolio (and nothing short, hence the 100/0 designation). Then it would take 20% of capital in offsetting long and short positions in under-and over-valued stocks (the 20/20). T here is inherent inefficiency in this approach as the 100% long market portion will involve buying some of the same over-valued stocks which are shorted in the 20% short position."

What I couldn’t understand well is the difference between 120/20 and the 100/0 plus 20/20 strategy. Why the 100% long position would not just buy undervalued stocks while 20/20 is long 20% undervalued and short 20% overvalued? Did I miss something here to difference the two strategies listed as comparison?

Thanks in advance!

#2

If the 100% portfolio is used for beta exposure, then the long+short will overalp the securities in the 100/0.

But if you used the 120/20 for under and over valued stocks, then no overlap occurs, however, the beta exposure is not well controlled in this situation, or in other words, not an objective.

#3

Thanks MrSmart, this starts to make sense now. smiley

So what Scheweser was trying to say is that they use a 100/0 long position to get market beta exposure so they long a market portfolio which include stocks that are undervalued and overvalued instead of choosing portfolios that are undervalued only. And further they use 20/20 to earn additional alpha exposure. This sounds like a alpha beta seperation or just to me?

#4

Only if the alpha is earned in a different market.

Otherwise, you may very well choose the same securities in both portfolios.

#5

Perect, thanks MrSmart!