Equitizing Long-Short Portfolio

I’m having trouble trying to understand what the point is to equitize a long-short portfolio. By nature a long-short portfolio would already have equity exposure. I understand why clients would want to equitize cash, but this topic seems like a PM is trying to equitize a equity portfolio.

It also differentiates between pair trading and equity futures by pointing out systematic risk (lack of and pursuit of, respectively. Then it immediately proceeds to state ETFs can be used to equitize a market neutral portfolio. This got me thinking : 1) can’t a mkt neut pf be equitized with futures then? Is the curriculum simply pointing out that ETFs are more efficient than futures when equitizing? 2)when a market neutral portfolio is equitized, would the portfolio be exposed to syst risk?

I believe my questions really stem from what equitizing a equity portfolio achieves. Is it a loophole to pf constraints? Are future and ETFs (for the purpose of equitizing) used interchangeably?

Generally if you are long 100% and short say 30% then you will have cash from the short sale proceeds . This is an alpha stratgey which presumably exploits your insights on both the long and short side. However you have reduced exposure to the market by being partially short .You may want more exposure through equity futures . So you might follow a process of equitizing the cash i.e. buy futures or ETF’s with the cash to gain systematic exposure.

I don’t think there is much difference between using futures or ETF’s to equitize cash other than the fact that futures are leveraged , and you may have some constraints against leverage.

pairs trading may be a form of market neutral strategy , i.e. a low beta . long equity futures offer nearly 100% market exposure so they’re beta=1

Thanks @janakisri.

Comparing this to the short-extension strategy, is it correct to say: the equitized long-short works by starting from a long-short pf (100/20) to use the short proceed to gain more mkt exposure (20, two-step). In contrast, the short-extension would over-long (ie 120/20) right off the bat (and wouldn’t use futures either).

You cannot go “over-long” without either borrowing ( which is what a futures instrument is : long equity futures - short a bond ) or using short sales proceeds.

The usual comparison is between (1)market-neutral + futures and (2) equity long-short

I think the difference is stated as where you earn alpha , how much leverage you use and how you gain the systematic exposure piece. Market-neutral equity long/short is usually implemented with concentrated positions in a few long equity instruments exactly offset in investment amounts with a few short equity bets. Even though the idividual positions are concentrated , the correlation to the market is low .

So if you want to up the correlation i.e. gain market exposure , you would use futures ( and you could use futures in any market in the world ). If there is a strong bull market , your portfolio could underperform because of the cost of leverage , plus your realized beta may not be 1.

Equity long-short ( in the traditional 130/30 or 120/20 schemes) is implemented with primarily long instruments and some degree of short exposure . The alpha is generated for both long and short positions through the same market. The beta is planned to be nearly 1 without using leverage through futures exposure, but again the realized beta may not be 1 , plus you would pay higher pays for the hedge fund manager’s “insights”. The long side could underperform during strong bull markets while the short exposure would guarantee losses on its side during such times.

I’m confused about equitizing long short portfolio too. My question:

if you short an overvalued stock and long a similar undervalued stock in the same industry to get beta=0, wouldn’t you exhaust your cash proceed at this point? Where do you have the money to place in treasury to earn the interest? I understand you can get into an equity future without putting down money, but I’m confused as where the money is from to put into treasury

client gives you the notional to invest . You have an alpha strategy and invest ( i.e. go long ) good undervalued stocks to the extent of the notional . You have some good ideas on overvalued stocks too . So you borrow the stocks ( maybe put the long stocks as collateral ) and sell them . This raises some cash whicj you invest in treasuries