FAQ

Why should an investor hedge their portfolio?
Hedging a portfolio provides superior performance relative to well-managed, long-only portfolios. 

A scholar named Alfred Winslow Jones perfected the short in the early 1950’s.  At the time, short selling was customarily used for speculation. Jones’ approach was unconventional. He postulated that maintaining a basket of shorted stocks would be able to protect his long-only portion of the portfolio against a drop in the overall market. It worked, and Jones was able to amplify his stock picking skills while having a permanent guard against market volatility.

Jones was able to calculate his capital exposure to market risk using the following formula:

Market Exposure = (Long exposure – Short exposure) / Capital
For example, if Jones was told he could leverage and short with a portfolio valued at $1,000.00, Jones would leverage his purchase of shares to $1,200.00 and sell short a value of $500.00. His gross investment of $1,700.00, or 170% of capital, would have a net exposure of only $700.00, or $1,200–$500. Jones ranked stock picking over market timing, but would nevertheless increase or decrease his net market exposure based on his estimation of market strength.

Jones found two sources of risk in an equity portfolio, stock selection and the market, and designed his system to maximize the first and minimize the second.  Using the above example, the $700 un-hedged position was exposed to stock picking and market risk, but the $1000 of hedged capital was exposed only to the risks from stock picking.
Jones concluded the following:

• In a rising market, good long selection would rise more than the market and good short selections will rise less than the market, thus creating a net profit in the hedged portion of the portfolio.
• In a declining market, good long selections would fall less than the market and good short selections will fall more than the market, thus creating a net profit in the hedged portion of the portfolio.

The portfolio manager believes the Active Bear Strategy serves as an excellent hedging vehicle by providing you with an entire portfolio of liquid short positions, allowing you to focus on selecting good long positions!

What if an investor just wanted to avoid a shorting strategy and just short the market?
An investor can. However, one of the drawbacks to shorting a security such as SPY is that the borrower inherits the obligation to pay the dividend. For example, if an investor wants to short the S&P 500 by shorting SPY, the investor will have to pay out the dividend.  The minute the order is filled to short SPY, the investor has already inherited a hurdle of three percent and will have to clear that first before breaking even.