1. …A Quantitative Approach
Global Asset Allocation
Term 3, 2005
Matthew Morse
Jason Teeters
J.J. Haines

2. Overview Hypothesis: Develop a market-neutral long/short strategy
Motivated by a “pairs trading” strategy which is designed to hedge industry specific risk
Identify a dynamic portfolio strategy which outperforms a general pairs trading strategy through the creation of a “basket” of securities
Industry-specific long and short “baskets” are identified on a monthly basis through a screen of targeted fundamental factors
Identify industry sectors which consistently produce excess returns

3. Overview Methodology:
Identify industries and potential fundamental factors
Screen and alpha test individual factors across industry sectors
Score and combine individual factors
Alpha test combined industry long/short “baskets”
Evaluate which industries produce consistent excess returns
Evaluate trading strategies

4. Industries Communications Manufacturing Transportation Consumer
Healthcare

5. Screens
Factors:
Short Interest - total short positions currently open for a given equity as a percentage of total shares
Fundamental Debt Factor - incorporates information about cost of debt and leverage ratio
Change in Consensus – Percent change in EPS estimate (IBES)

6. In Sample

7. Healthcare
Communication
Consumer Products

8. Manufacturing
Transportation

11. Healthcare – In Sample

12. Communications – In Sample

13. Consumer – In Sample

14. Manufacturing – In Sample

15. Transportation – In Sample

16. Out of Sample

17. Healthcare
Communication
Consumer Products

18. Manufacturing
Transportation

21. Healthcare – Out Sample

22. Communications – Out Sample

23. Consumer – Out Sample

24. Manufacturing – Out Sample

25. Transportation – Out Sample

26. Optimization

27. Optimization
Value Weighted
Equal Weighted

28. Conclusions
Intra-sector excess returns appear to be consistently available
Inconsistent “in-sample” and “out-of-sample” results within certain industry sectors
Additional analysis should lead to effective factors which could consistently produce intra-sector excess returns

29. Next Steps
Develop and evaluate additional factors which isolate industry specific excess returns
Test additional industry sectors and sub-sectors in-sample
Vary factors weights across industries
Evaluate migration of stocks within fractiles
Develop and evaluate sector-specific, and overall, trading strategies as part of an overall hedge fund charter