Browse Analysis of Managed and Structured Products

21.2.3 Directional Strategies

In-depth exploration of directional investment strategies including long/short equity, global macro, emerging markets, dedicated short bias, and managed futures strategies. This chapter covers essential concepts, examples, mathematical calculations, and advantages and considerations.

Directional Strategies

Directional strategies involve high exposure to market direction and include the following types of strategies:

  • Long/Short Equity Strategies
  • Global Macro Strategies
  • Emerging Market Strategies
  • Dedicated Short Bias Strategies
  • Managed Futures Strategies

Long/Short Equity

The long/short equity strategy is a popular alternative fund strategy in Canada. These funds are directional since the manager maintains either a net long or net short exposure to the stock market. Unlike an equity market-neutral strategy which eliminates market trends, this strategy involves taking both long and short positions depending on the securities’ outlook.

Managers in a long/short equity strategy aim to:

  • Bull Market: Buy stocks expected to perform better than the market and short stocks expected to perform worse.
  • Bear Market: Expect good short selections to decline more and good long selections to decline less.

Net Exposure Calculation

In a long/short equity strategy, net exposure determines market risk and is calculated as follows:

$$ (Net Exposure = \frac{\text{Long Exposure} - \text{Short Exposure}}{\text{Capital}}) $$

Comparison to Equity Market Neutral Strategy

  1. Equity Market-Neutral Strategy: Aims for zero beta, bypassing market movements by pairing stocks with identical market values.
  2. Equity Long/Short Strategy: Has inherent market exposure, meaning portfolio beta is not zero.

A manager might adopt one of two strategies:

  1. Market Neutral with Futures: Combines an equity market-neutral portfolio with an equity index futures position.
  2. Unbalanced Pair Trades: Involves non-equal valuing of long and short positions, adding net market exposure without derivatives.

Example: Long/Short Equity Strategy

This example demonstrates a strategy of the first type with exposure to a long position in an S&P/TSX 60 futures contract.

DID YOU KNOW? The S&P/TSX 60 Index times $200 equals the market value of a futures contract.

Example Calculation for November 1, 2018 to March 1, 2019

Security Position Market Value/Index
Royal Bank of Canada Long $798,668
Toronto Dominion Bank Short $751,600
S&P TSX 60 Futures Long $191,646

Total: 58,575.82 C$, equating to a 7.92% Return on Investment and an annualized RoR of 23.75%.

Global Macro

Global macro strategists base their decisions on substantial events influencing entire economies. They trade in markets involving equities, bonds, currencies, and commodities, using leverage to amplify market moves.

Key Monitoring Factors

  • Trade statistics
  • Corporate earnings
  • Exchange rate dislocations
  • Domestic/foreign policy
  • Investor biases
  • Political/Economic events
  • Central bank interventions

Two analysis styles:

  1. Discretionary Managers: Use top-down analyses predicting market resolutions and movements of asset classes.
  2. Systematic Managers: Utilize bottom-up analyses leveraging models and algorithms.

Example

Predicting consequences of U.S tariffs on Japanese exports, a global macro manager could short Japanese manufacturing indices and the Yen, while hedging through long positions in U.S. manufacturing.

Emerging Markets

These funds invest in equity and debt securities from emerging markets. They significantly utilize derivatives, short selling, and sophisticated financial strategies compared to standard mutual funds.

Factors Affecting Investment

  • GDP growth rate
  • Political and social stability
  • Market regulation levels
  • Environmental factors

Portfolio diversity can be specific (commodities in Africa/South America) or varied (BRIC: Brazil, Russia, India, China).

Risks

  • Political and currency risk
  • Inflation and liquidity concerns
  • Transparency and regulatory issues

Most emerging market strategies are long-only due to regulatory constraints.

Dedicated Short Bias

Funds classified as short bias maintain a net short position but can have long positions. Strategies differ from naked short funds focused solely on short positions.

Risks & Skills

  • Overpriced securities identification using fundamental/technical analysis
  • Maintaining margin balance to avoid forced position closure
  • Managing long positions in market downturns

Managed Futures

Managed by professionals, these strategies involve futures contracts actively traded. Known as commodity trading advisors (CTAs), they offer advice specific to futures and operate under separate regulatory frameworks.

Trend-Following Strategies

  1. Time-Series Momentum: Uses historical data to predict future trends and invests accordingly.
  2. Cross-Sectional Momentum: Pairs securities by relative signals, long positive vs. short negative trends.

Futures Categories

  • Commodities: Gold, oil
  • Currencies: Yen, US Dollar
  • Stock Indices: S&P, NASDAQ
  • Fixed Income: US Treasury bonds

Benefits

  • High liquidity
  • Low friction costs
  • Price transparency
  • Direct risk exposure (e.g., gold prices)

DID YOU KNOW? Systematic futures managers invest across uncorrelated markets.

Managed Futures Subset - Currency

Assets are managed using money market instruments and derivatives, designated either globally or for a single currency. Academic research supports including currency exposure in standard portfolios to increase returns for given risk levels.

Key Takeaways

  • Directional Strategies: Involve various strategies leveraging market movements.
  • Long/Short Equity: Benefits from market fluctuations using long and short positions.
  • Global Macro: Aligns with major economic events; diverse assets and leverage use.
  • Emerging Markets: High risk, yet higher return with distinct strategies.[type, location]
  • Dedicated Short Bias: Maintains net shorts, balanced risk of long/short barriers.
  • Managed Futures: Professional handling of diverse futures focused on trend- tracking and momentum.

CSC® Exams Practice Questions

📚✨ CSC Exam Questions ✨📚

Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck!

## What is the primary objective of a long/short equity strategy? - [ ] To have zero market exposure - [ ] To only hold long positions - [ ] To only hold short positions - [x] To hold both long and short positions simultaneously based on the outlook of specific securities > **Explanation:** The long/short equity strategy involves taking both long and short positions depending on the manager’s outlook on specific securities, aiming to profit in both up and down markets. ## How does the net exposure of a long/short equity fund compare to that of an equity market-neutral strategy? - [ ] It has zero net exposure - [x] It has net exposure to the overall market - [ ] It only goes short on stocks - [ ] It eliminates market effects completely > **Explanation:** An equity market-neutral strategy seeks to eliminate market effects and has zero beta, whereas a long/short equity strategy maintains some net exposure to the market, meaning its portfolio beta is not zero. ## Which of the following correctly describes a global macro strategy? - [x] It involves making bets on major economic events affecting entire economies - [ ] It focuses on investing in niche markets only - [ ] It avoids the use of leverage - [ ] It only invests in domestic stocks and bonds > **Explanation:** Global macro strategies involve making investments based on major events affecting entire economies, including shifts in government policies affecting interest rates, currencies, stocks, and bonds. ## What type of analysis do discretionary managers typically use in a global macro strategy? - [x] Top-down analysis - [ ] Bottom-up analysis - [ ] Technical analysis only - [ ] Moving average analysis > **Explanation:** Discretionary managers in global macro strategies typically use a top-down analysis approach, analyzing the world economy to predict the direction of underlying markets and asset classes. ## In an emerging markets strategy, what additional risk is often considered beyond those faced in developed markets? - [ ] Inflation risk only - [ ] Currency risk only - [ ] Political risk only - [x] All of the above > **Explanation:** Emerging markets strategies face additional risks such as political risk, currency risk, and inflation risk, alongside other inherent risks in under-developed capital markets. ## What defines a dedicated short bias fund? - [ ] It must always have long positions - [ ] It can only take naked short positions - [x] It must always have a net short position - [ ] It balances equality between long and short positions > **Explanation:** A dedicated short bias fund must always maintain a net short position but may hold long positions as well. ## What is the primary focus of managed futures strategies? - [ ] Investing exclusively in equity and debt securities - [x] Actively managing a portfolio of futures contracts - [ ] Only investing in domestic futures markets - [ ] Avoiding the use of derivatives > **Explanation:** Managed futures strategies involve actively managing a portfolio of futures contracts across various categories like commodities, currencies, stock indices, and fixed income. ## Which management style in global macro strategies involves the use of models and algorithms? - [ ] Discretionary management - [x] Systematic management - [ ] Fundamental management - [ ] Random walk management > **Explanation:** Systematic managers use models and algorithms on large sets of economic data to predict financial market prices. ## Which trend-following strategy involves taking positions in pairs of securities based on relative signals? - [ ] Time-series momentum - [ ] Mean reversion - [x] Cross-sectional momentum - [ ] Arbitrage > **Explanation:** Cross-sectional momentum strategy takes positions in pairs of securities based on relative signals, going long on securities with positive signals and short on those with negative signals. ## What is one common strategy employed by managed futures managers? - [ ] Buy-and-hold strategy - [x] Trend-following strategy - [ ] Dividend yield strategy - [ ] Growth investing > **Explanation:** Managed futures managers often employ a trend-following strategy, seeking out securities that have moved in one direction for an extended period.

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Sunday, July 21, 2024