130/30 lower tracking error than active long

page 208 book 4 its a 130/30 sales pitch. the thing which threw me was that tracking risk is lower than active long only. the argument holds a little - 130/30 would use an index forward. then investing the remainder outside of the index universe provides unsystematic returns. OKish then the case against active trackers - a small number of key stocks mean that it’s very difficult to actively manage with little tracking error. this seems wrong, a small number of stocks should mean it’s easier to track the index, so easier to miss out stocks which underperform (the flatliners). google found this - http://www.ftseglobalmarkets.com/issues/2009-guide-to-investing-in-130-30-funds/the-strengths-and-weaknesses-of-130-30-investing.html " This is why the shorting was interesting: it allowed managers to target higher tracking errors than if they were long only" totally confused now.

The 130/30 strategy in equity portfolio mgt isn’t realy a tracking error issue, per se. It is a sales pitch but in this manner…if you try and get clients to short securities, particullary hedge funds, the clients may get nervous especially with the unlimited risk should the security appreciate rather than the anticipated depreciate. So with the 130/30 strategy managers can pitch the idea that they at one time long ago bought say 100 long stocks. Now as time passed several of those stocks maybe be overvalued, 30 of them for giggles, and they are ripe for a short. Now the manager can tell the client we have a covered short sell and the risk is not nearly as great. It a more palatable stratgy for some in the private client wealth arena. This is why this section of the reading is found in the Long short investing section 5.2 and follows the “reasons to short.”

Volume 4, Reading 23, Section 5.3.4 page 208-209

Be very careful going outside of the candidate curriculum as the exam can only be written from what is in the curriculum. You may disagree with the reason, rational, methodology etc…but that would be considered incorrect on the exam as it deviates from the reading. Just saying…;-))

having now reread it 5 times, I think I understand…

to outperform, you must concentrate research on the small number of key stocks in the index. this is what everyone else is doing. and it’s therefore very difficult to find alpha.

a better option is buy the index, and look elsewhere for alpha.

so active long -> high tracking error -> difficult to find alpha.

130/30 -> zero tracking error + pure alpha.

i.e. the ftse link is pure BS