Simulating an Ideal 130 30 Portfolio

PortfolioHedge funds and stock pickers love the 130 – 30 portfolio structure. Oliver Stone’s Wallstreet sequel “Money Never Sleeps” even features it in the big comeback scene. We get a glimpse of Gordon Gekko’s computer screen as he parlays his hidden $100 million to up over $1 billion in assets under management. “My guys are the best,” he proudly touts, and we see the classic hedge fund asset allocation on his screen: 130% long, and 30% short, netting to 100% long over $1 billion AUM.

We used Portfolio Workstation to simulate how the 130 – 30 portfolio might look like for a skilled stock picker working with the Nasdaq 100 (pictured upper right). In order to do this, we made the assumption that whomever picked the stocks in the portfolio was capable of picking long positions from the top of the second quartile of returns, and short positions from the top of the bottom quartile over the period under study. The time period is January 1, 2007 to present, as shown in the Chart Controls windows in the included screenshots. To be very clear, we are exploiting the benefit of hind-sight to identify what those stocks are for this study with the intent to illustrate what a skilled stock picker might have been able to realistically achieve.

Sorting the Nasdaq 100 constituents by performance for the period under study and selecting a small sample of stock picks as outlined leads to the following:

Long positions: SBAC, CELG, SIAL, CHPK, DISCA

Nasdaq 100 sort by returns second quartile

Short positions: ADBE, PCAR, YHOO, PAYX, MSFT

Nasdaq 100 sort by returns fourth quartile

The 130 – 30 portfolio allocations from these picks is illustrated in the following screenshot. The positions are fixed fractional allocations and are maintained by rebalancing daily at both the open and the close with a cost estimate of 0.25% slippage per trade. Note that the long stock picks add up to 90% allocation, and there is a 40% allocation to the treasury bond fund TLT. The short position allocations add up to negative 30%. This sums to 100% as follows: 90 + 40 – 30. Even though we are doing lots of stock picking on both the long and the short side, we are still preserving the basic tenet 60% stocks (net) and 40% bonds.

Portfolio allocations

Let’s have a look at how the hypothetical portfolio stacked up to our benchmark, QQQ over the same period. All of these stats shown are computed based on daily time series, so only compare them to each other. For example, comparing these sharpe ratios to sharpe ratios calculated elsewhere based on monthly returns won’t work.

Stats side by side

We find the most interesting difference to be the Sortino Ratio, which more than doubled the benchmark. The Total Return was almost twice as good as the benchmark. The 2008 financial crisis was the largest drawdown for both, but the hedged portfolio fared much better with only a 27.5% drawdown, vs 54.5% for the benchmark. Looking at the ratio chart with our portfolio in the numerator and QQQ in the denominator, it becomes clear that the portfolio gained most of it’s ground over the benchmark during the financial crisis (pictured next).

Portfolio QQQ ratio

The next image is the correlation matrix for all of the constituents of the portfolio, sorted starting with the least correlated to the entire portfolio (YHOO 0.588) towards the most correlated (SBAC 0.951). We note that the 5 least correlated are all the short picks. TLT almost appears to separate the longs and the shorts, but CELG got in the way of that clear divide.

Portfolio correlations

For completeness, the charts and stats forĀ  QQQ and TLT during the period under study are included below.

QQQ

TLT

Posted in Uncategorized.

Leave a Reply