GLOBAL - Allowing short positions could impair portfolio performance, according to a paper published recently in the Journal of Asset Management.
Using historical data, the authors - three econometricians and a quant working for a Swiss fund manager - found that 130/30 versions performed worse than their long-only counterparts.
The researchers replicated a 'realistic' portfolio from 2,500 return scenarios for each period studied. The portfolios included higher transaction fees for short positions and restricted short sales to a list of large, liquid stocks.
Despite the report's findings, its authors rejected the assumption made by previous studies that institutional investors should effectively rule out short selling.
"Theoretically," they said, "short positions can improve the risk/return characteristics of a portfolio, and practically, institutional investors can and do sell stocks short."
The authors also concluded that allowing short positions offered arbitrage opportunities because the algorithm could finance favourable positions by selling short less attractive assets.
Although for some alternatives, drying up of liquidity can lead to "short squeezes", the study - 'Constructing 130/30-portfolios with the Omega ratio' - concluded that options in future positions could be constructed to behave like short positions, albeit with slight differences in cash positions and counterparty risk.