NEW YORK — Pension plans need to take the short-constraint handcuffs off of their money managers if they want better returns, according to a recent white paper issued by JPMorgan Asset Management, New York.
Institutional investors that only allow managers to buy and hold stocks in a particular index are missing out on opportunities to take advantage of manager skill, the paper said. When limited to only taking long positions, a portfolio manager does not have the opportunity to make money from overvalued stocks. In fact, according to the paper, the long-only manager only has the opportunity to underweight or shun overvalued stocks and could lose returns in the process.
The paper challenges the traditional notion that the measure of manager skill, also called the "transfer co-efficient," increases when a manager invests a large amount of a portfolio in a small number of securities that the manager finds attractive. The paper also said that giving managers the freedom to short, by extension, increases the information ratio of a portfolio because portfolio managers are given more freedom to use their skill than if they were managing a long-only portfolio. An information ratio is a measure of return based on the risk that a portfolio manager takes.
Last year, JPMorgan jumped into the small pool of managers offering strategies in which short positions are allowed in a small portion of a long-only portfolio. JPMorgan manages about $200 million in such strategies, dubbed the "120/20" and the "130/30" portfolios, named thus because the portfolios are long-only, but the manager shorts 20% or 30%, respectively.
Other money managers offering such strategies are State Street Global Advisors, Boston; Barclays Global Investors, San Francisco; INVESCO, Atlanta; and Goldman Sachs Asset Management, New York.
"As more of the portfolio's market value is invested in a smaller and smaller number of names, the quantity and size of perverse negative bets (bets on stocks that the portfolio manager finds unattractive) resulting from not holding stocks which the manager may find somewhat attractive reduces the transfer coefficient," according to the paper.
"This is a much more elegant and effective way to deliver alpha," said Paul Quinsee, chief investment officer for equities, in an interview. "We are not looking to replace a well-managed long-only portfolio. The question we are responding to is, ‘How can I generate more alpha?'"