Long-Short strategies rely to various degrees on the ability to bet on stocks with negative expected return. This may require taking short positions. Which of the following lists shows the three common long-short strategies ranked in decreasing order of reliance on short-selling (from the one who needs it the most to the one who needs it the least)?Group of answer choices130/30, Smart Beta, Market NeutralMarket Neutral, 130/30, Smart BetaSmart Beta, 130/30, Market Neutral130/30, Market Neutral, Smart Beta
Question
Long-Short strategies rely to various degrees on the ability to bet on stocks with negative expected return. This may require taking short positions. Which of the following lists shows the three common long-short strategies ranked in decreasing order of reliance on short-selling (from the one who needs it the most to the one who needs it the least)?Group of answer choices130/30, Smart Beta, Market NeutralMarket Neutral, 130/30, Smart BetaSmart Beta, 130/30, Market Neutral130/30, Market Neutral, Smart Beta
Solution
The correct order is: Market Neutral, 130/30, Smart Beta.
Here's why:
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Market Neutral: This strategy is heavily reliant on short selling. It involves taking a 50% long and 50% short position in the market, hence the term 'neutral'. The aim is to profit from both increasing and decreasing prices in one or multiple markets, by making the relationship between long and short positions neutral.
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130/30: This strategy also involves short selling but to a lesser degree than Market Neutral. It involves taking a 130% long position and a 30% short position. The extra 30% short position is used to fund an additional 30% long position. This strategy is used when investors want to have a net long position in the market, while also taking advantage of certain stocks they believe will decrease in value.
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Smart Beta: This strategy has the least reliance on short selling. Smart Beta strategies seek to passively follow indices, while also taking into account factors that can provide better risk and return trade-offs. The strategy does not necessarily require short selling, as it can be implemented by simply overweighting and underweighting certain stocks in the index.
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