Long-Short Optimization

Long-short strategies are popular among investment managers, so New Frontier has provided several tools to facilitate long-short optimization. Enabling long-short optimization through the Options Menu permits long-short optimization in the Optimizer. The Optimizer reminds users that long-short has enabled by listing it on the Optimization Options Bar. The distinguishing characteristic of long-short is the ability to constrain the total long and short portfolios.

Long-short optimization has far-reaching effects:

• Asset Bounds: Enabling long-short optimization only affects the optimization results if you also adjust the asset bounds to permit long and short selling of particular assets. Do not leave the optimization problem unbounded. Reasonable asset bounds prevent the Optimizer from searching for answers that reach to infinity.  

• Charts: Enabling long-short optimization changes the availability of certain charts. For example, the pie charts do not handle negative numbers, and therefore do not appear when long-short optimization is enabled. Portfolio composition maps still appear, but strangely; enlarging the number of frontier points decreases the choppiness of the charts. The mean-variance variant of the composition map does not appear.

• Infeasibility: It is easy to set up an infeasible optimization problem with long-short constraints and asset bounds, so be very careful. In particular, remember that to satisfy the portfolio constraint, long and short bounds must always agree such that the Short Min % subtracted from the Long Min % sums to 100% and the same for the upper bounds.  

• Cash: Unlike equity optimization, most asset allocation long-short strategies do not have a cash asset to absorb differences.

• Options Strategy: Long-short optimization requires special attention when using option overlays.  Short assets with options will reverse the buy/write status for their options.  For example, a put option which would normally be bought when its underlying instrument is long, will be written when the asset is short.  It will no longer have the insurance function against losses resulting from changes in the underlying price.

You can provide guidelines as to what percentage of the entire portfolio that can be long and short sold in the Portfolio Bounds Fields at the bottom of the Constraints Worksheet. These are soft constraints, so the final portfolios may not fall within the bounds exactly. Enter the approximate maximum percentage of all shorted stocks in the Short Portfolio Max % field, etc. Entering 100-200% as long bounds indicates that the total of all long assets will be close to 100% of the total portfolio and less than 200% of the portfolio.  

Examples:

• For a simple long-short portfolio, enter "100" as the Long Portfolio Min %, "200" as the Long Portfolio Max %, "0" as the Short Portfolio Min %, and "100" in the Short Portfolio Max % field. The Optimizer is likely to find more and more leveraged portfolios as the risk increases along the Michaud Resampled Efficient Frontier.  

• For a more complicated example of constraints, assume you have a desire for a $100 portfolio to have between $50 and $100 in Asset A, between $100 and $150 long, and between $0 and $50 short. To implement these constraints, enter "150" as the Long Portfolio Max %, "100" as the Long Portfolio Min %, "0" in the Short Portfolio Min % Field, and "50" in the Short Portfolio Max % field.  To restrict Asset A to the required range, enter asset bounds of 50% and 100%.  

Shorted assets appear as negative weights within the optimal portfolios.