question 7 in reading 27 of CFAI, says to build a market neutral long short strategy using UK equities and no japanese equities. Is the solution saying that we should managed a market neutral long short portfolio strategy and go long the position in UK equities future while shorting the japanese equity futures? I don’t find the solution really clear as to what we should do.
Thank you in advance,
Market neutral long short on UK Equities - e.g. 2 companies in the same industry - go long on one, go short on the other, for equal amount. This part of the portfolio provides you with the alpha. If the Undervalued (Long) gains, while the Overvalued (Short) loses - you get alpha from two sources. This portion being from the same industry, is beta neutral (no market risk).
For getting Japanese Equities exposure - you need to go long the Japanese Equity Futures. This will provide you Japanese Market beta.
the problem says you want exposure to UK equities and no exposure to Japanese equities. so do you go with the long/short strategy on uk equities and then enter into a short futures contract on japanese equities to swap beta exposure?
Alpha Portability: Alpha available to be added to variety of systematic exposures.
Hayes, who is an expert long short manager, learns that Client is looking to hire separate manager to manage Japanese portfolio. Hayes can himself satisfy this by taking a long position in Japanese futures (beta) while continuing long short strategy in UK equities (alpha). Mandate is satisfied such that no actual exposure to Japanes equities (only exposure in NP of futures, may be trading in UK bourses only). Revision in mandate should be sought for.
I am still not very clear the rationale behind of a long-short strategy. I understand that there could be two alphas, one from the long and the other from the short. However, wouldn’t the underlying stocks move in the same direction most of the time since they are in the same industry? I.e. the long gains and the short loses at the same time, or the long loses and the short gains at the same time. Overall alpha should be close to 0.
Can anyone enlighten me?
since you shorted it, and market moved down - you get alpha because the short lost more… and you made a bet on it.
if you bought something and it gained more - you gain alpha.
This is in the case that the bets you made were the same directional moves.
but if the move afterwards were against your bet - viz. long security falls, and/or short security gains - you lose.
the other part - you are making an active bet here. you would select the long company based on its fundamenetals and so on, and decide that it is undervalued before you place your bet. It is not that since they are in the same industry - that if company A moves up (Long) that Company B (your short) should also move up.
If it is an active bet on two different companies, why would the overall beta is 0?
in the same industry. so no market risk (market affects both companies the same way, any differences are now company specific ONLY) - so overall beta is 0. By making the two market, industry, sector and Dollar neutral - the Long short strategy has a beta exposure of 0.
tks cpk