Thursday, July 16, 2009

What's My Line?

Professional traders always know what their factor exposure is to the market. Are their holdings tilted towards Small or Large caps? Growth or Value stocks? Finance or Material sectors?

In this way, they are aware of how their portfolio may respond to industry specific news and broad market changes alike. By knowing the exposure of their line in toto, they can hedge against unexpected moves without having to sell the whole lot. If their individual picks have a true edge, they should outperform without regard.

If you have more than a handful of stocks in your portfolio, you may be surprised what your real exposure is. The latest addition to the ETF Rewind suite allows the active trader to more intelligently answer this question without falling back on simple dollar-weighted S&P hedges. System traders who automatically generate their trade candidates will find the tool especially helpful, as it also downloads the name, sector and industry sub-sector for each entered symbol.

As a simple example, I ran the MS Excel spreadsheet against 40 of today's reporting companies. With such a big list, it's a pretty diversified portfolio, but even so you can see it has a small-cap value skew with an aggregate emphasis on financial and service sector exposure. On top of that, the portfolio's beta (the extent it would hypothetically move relative to the market) is a quite levered 1.4+, meaning if you were to hedge with a straight S&P short, you would sell 1.4:1. (Note that non-equal weighted and short positions can also be entered.)

Between this new short-term exposure hedging feature and the longer-term portfolio variance minimization feature (a "Modern Portfolio Theory Efficient Frontier" calculation), ETF Rewind users now have two very powerful tools to better manage risk across multiple time frames without relying on pure market timing. So - What's Your Line?

No comments: