Introduction to the investment strategy
This strategy is built around a combination of the FF Quality Rank and the FF Sentiment Rank for industries and stocks. The strategy belongs to the hedge fund category ‘Equity Long/Short’. By using this strategy you invest in ‘high-quality’ stocks with solid sentiment, all within ‘high-quality’ industries, while at the same time going short large cap stocks.
Portfolio composition – how are the positions determined?
The investment portfolio consists in this strategy of long and short stock positions. The stocks selected for inclusion in the portfolio are determined in the following way:
For the long sub-portfolio:
- The top 10 quality industries are established. This is done by aggregating the individual stock scores in all of the industries that our investment universe is divided into. This step is taken in order to achieve a good level of diversification. We do not want to concentrate the stock positions to merely a few industries.
- From the top industries, the stocks selected are those with an FF Quality Rank of #1, a ‘Strong Buy’, that simultaneously has an FF Sentiment Rank of at least #2, i.e. they are at least ranked as a ‘Buy’ along the sentiment dimension.
- The long sub-portfolio typically consists of 0 – 20 stocks over time.
For the short sub-portfolio:
- Short S&P 500, either through futures, e.g. E-mini S&Ps, or an ETF, e.g. SPDR S&P 500, SPY.
Entry/exit – when are the positions changed?
Portfolio updates are determined on a weekly basis, after the weekly update of FF Stock Rank. No new positions are established and no stocks are dropped from the portfolio between the portfolio updates.
The exposure of the long stock positions is in the range 0% – 100% the exposure on the short side is between 0% and 50%. The net exposure, when fully invested, averages 50% over time. A margin account is needed to implement the strategy.
The risk of loss is handled by means hedging; going long stocks that are expected to increase in price and at the same time shorting a broader market portfolio. There is also industry diversification – the stocks in the portfolio are selected from 10 industries.
Results – what to expect?
This is a neutral to aggressive strategy with an expected long-term return of 12% – 16% per year, a lower annual standard deviation and a Sharpe Ratio of 1.1 – 1.5.
Risk – which types of market environments are detrimental to the strategy?
The strategy experiences hardship in the short term when the sentiment turns around for one or more industries or a number of stocks. This typically occurs after significant run-ups in price.
Also, a situation of a general market down-turn is to some extent negative to the strategy as the portfolio is net long and the correlation with the general market can be expected to be positive on the up-side as well as on the down-side.