How does a 130/30 long-short equity strategy enhance returns vs long-only?

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AcadiFi · Accepted Answer

A 130/30 strategy holds 130% long positions and 30% short positions, netting to 100% market exposure. It relaxes the long-only constraint, allowing managers to express negative views on overvalued stocks they'd otherwise just underweight to zero. The efficiency gain comes from the transfer coefficient. In a long-only world, a manager who believes stock X will underperform can only avoid it (max underweight equals index weight, often 10-30 bps). In 130/30, the manager can short X by 1-2%, giving the signal full expression. The Fundamental Law of Active Management implies that relaxing long-only can improve IR by 25-50%. Worked example: Finchcrest Capital runs a 130/30 US large-cap mandate. With IC 0.05 and breadth 200, long-only IR ≈ 0.5 × 0.05 × sqrt(200) = 0.35. With the short constraint relaxed, effective transfer coefficient rises from 0.55 to 0.85, boosting IR to roughly 0.55. At 3% TE, expected alpha rises from 105 bps to 165 bps. Costs to net: short financing (roughly SOFR + 25-75 bps on hard-to-borrow), higher operational complexity, potential short squeeze risk, prime broker fees, and higher management fees (60-90 bps vs 30-45 for long-only). The break-even extra alpha to justify 130/30 is typically 30-40 bps over comparable long-only. For your client, compare realized IR net of fees over 3-5 years. Good 130/30 managers deliver 60-80 bps net alpha with better Sharpe ratios than long-only peers.

How does a 130/30 long-short equity strategy enhance returns vs long-only?

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