Timing Equity Quant Positions with Shorter-Horizon Alphas
Journal of Trading, Summer 2016
Posted: 26 Feb 2016 Last revised: 11 Jan 2019
Date Written: February 26, 2016
In this research note we demonstrate some simple strategies for using relatively fast‐moving alphas to improve the timing decisions of systematic equity portfolios based on slower‐moving alpha signals.
Many managers are aware of the alpha in short‐horizon signals, but do not use these alphas due to their high turnover; the portfolio may be large, or the mandate may not call for mid‐frequency trading. We find that short‐term alphas can be used by such managers to time trades that a longer‐horizon strategy would enter regardless, thereby improving the price of the entry and exit points without incurring incremental transaction costs.
We demonstrate that a basic market‐neutral fundamental and momentum strategy with annual net returns of 5.5%, a net Sharpe Ratio of 0.55, and daily turnover of 6.4% can be improved to annual net returns of 10.0% and a net Sharpe Ratio of 0.97, with a slight reduction of turnover, by implementing simple entry and exit rules based on a short‐horizon alpha. The value added is very consistent over time, offers drawdown protection in volatile markets, and survives reasonable transaction cost and latency assumptions.
Short‐horizon alphas can therefore be effective as tactical overlays which can improve risk‐adjusted returns without unduly influencing the underlying strategy. The implementation could be as straightforward as a daily pre‐trade screen on position entries and exits prior to the open.
Keywords: portfolio management, quantitative strategies
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