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Shorting equity factors doesn’t add value, says Robeco research

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A common perception amongst academics and investors is that factor premiums, like Momentum, Value and Low-risk, exists in equity markets and should be best harvested via both long and short positions. But a team of three quant researchers and portfolio managers at Robeco have critically assessed the added value of shorts positions to harvest equity factors, and contrary to general market consensus, have found that there are none.

David Blitz, Pim van Vliet and Guido Baltussen made a breakdown of common equity factor strategies into their long and short legs, and found that (i) most added value tends to come from the long legs, (ii) the long legs of factors offer more diversification than the short legs, and (iii) the performance of the shorts is generally subsumed by the longs. In other words, equity factors may be more efficiently harvested by dropping their shorts.

They looked at returns on US stocks from 1963 to 2018. After testing a long strategy, a short strategy and a long-short strategy, risk-adjusted returns turned out better in all cases for the long-only strategy.
 
The authors took many approaches to assessing this finding, and they prove to be very robust. These results hold across large and small caps, are robust over time, carry over to international equity markets, and cannot be attributed to differences in tail risk. Moreover, it does not even account for the substantially higher implementation costs involved with the shorts compared to the longs.

The research also challenge recent claims that the value and low-risk factors are subsumed by the new Fama-French factors, as the team found that this result is entirely driven by the short legs of these factors and breaks down for the longs. Altogether, the findings show that long legs of factor portfolio are crucial for understanding factor premiums and building efficient factor portfolios.
 
So the authors say, the real question you should ask yourself is, ‘why would you short stocks in your factor strategies?’ and not ‘why don’t you short equity factors?’
 

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