Performance of Active Extension Strategies in the Australian Equities Market

Abstract

This dissertation examines the performance of active extension strategies, also known as ‘130/30’, in the Australian equities market. This strategy involves introducing short positions to 30% of the value of a fund while increasing the number of long positions to 130%, providing 100% net exposure to the market while giving the ability to take a larger number of active positions. A detailed analysis of the factors affecting performance is explored using a simulation approach based on eight years of historical returns for the constituents of the S&P/ASX 200 index and a variety of realistic cost assumptions. This study builds on previous analysis by using a simulation approach that allows a larger number of contributing factors to be analysed with greater precision. There is also a unique advantage to using active extension strategies in the Australian market, as a higher level of benchmark concentration relative to other major developed market indexes should lead to a higher performance increase from active extension strategies over traditional long-only portfolios. This is also one of the first analyses of this kind in the Australian market and should have a high degree of relevance to institutional investors considering active extension strategies. This study finds a statistically significant increase in performance from active extension strategies over equivalent long-only portfolios, holding all other factors constant. This increase is greatest for managers with higher levels of skill, where the manager is equally skilled at picking long or short positions. The performance increase from active extension portfolios is greatest where any tracking error limit is high and costs are low. Volatility and cross-sectional dispersion of returns, two factors hypothesised in the literature to affect the relative advantage of active extension strategies, are found to have no discernable effect. Similarly, there is no measurable difference in relative performance in rising or falling markets. Overall, this study concludes that there is a performance gain in relaxing the long-only constraint, provided costs are low, any tracking error target is not extremely low, and the manager has a reasonable degree of skill in selecting stocks both long and short.