Essay About Short Products And Dimension Of Risk

Hedge Funds
3. Which strategy is more risky ‐ long/short or long‐only? What is the motivation behind offering Equitized Long‐Short products? Where is the value added?In determining which of the two strategies is riskier, it’s imperative to appreciate the dimension of risk we are evaluating. Here, we consider both traditional total security risk in terms of the risk of the underlying portfolio, but also other risks to the firm and also the industry as a whole from running both strategies.Systematic risk is likely to be lower for a long/short portfolio if the beta on the long leg at least partially offsets the beta on the short leg of the strategy. However, if the short leg is in negative beta stocks whilst the long leg is in positive beta stocks, then a long/short strategy could feasibly have greater systematic risk than a long only strategy. Of course, there is an un-diversifiable risk, namely the idiosyncratic risk which could well be exaggerated in a long/short strategy. The long/short strategy for Numeric typically has a greater basket of stocks (300-400) than the long-only strategy (100+), so the idiosyncratic risk from any single stock has a relatively smaller impact on the overall portfolio in the long/short strategy by simple mathematical fact.Taking a short position in a stock theoretically has an unlimited downside risk; there is no ceiling on how high a stock price may go. Short positions are exacerbated as they move further away from the entry level so rebalancing the position will require discipline and an absence of loss aversion, which may be difficult in practice. Moreover, stocks are vulnerable to short squeezes when the stock is recalled, forcing a short strategy to realize losses at difficult times. In addition, short positions are liable to liquidity risk, during a liquidity crisis for example, funding short positions can become excessively costly and increase the risk to a long/short strategy.