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hughiejessel
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Joined: February 21st, 2023, 8:39 am

Equity styles for higher cross-sectional moments

February 21st, 2023, 9:48 am

Based on the second, third, or fourth moments of the cross sectional distribution of returns of a sub-sector (e.g. biotech), should that sector be more (or less) conducive to:
 
  1. A concentrated investment style (as opposed to a more diversified approach), and/or
  2. A long/short style (as opposed to long only)?
 
Background to the question: the narrative around biotech I have heard from other allocators is effectively the difference between the top decile of performers and the rest of the space is so much larger than most industries that you need to be concentrated to get exposure to one or two of those big winners. The other narrative is that the bottom quartile basically all go to zero, and therefore a long/short approach makes sense as you can make good alpha on the short side too. I am questioning the logic of this narrative
 
Without leading the witness, my bias is concentrated and long only, whereas the 'optimal approach' is clearly diversified and long/short, so I am not seeking to challenge the superiority of the latter approach in general, but simply whether it’s more or less appropriate for biotech than other industries given the extremeness of the cross-sectional distribution of returns.
 
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Alan
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Re: Equity styles for higher cross-sectional moments

February 22nd, 2023, 2:38 pm

1. Why are the most successful (publicly offered) funds (in terms of long-term performance) low cost, cap-weighted index funds and *not* long-short funds?

2. Let's say "the bottom quartile will basically all go to zero". I suspect that will be due to failed clinical trials. If you could predict those, you would be off creating a new Medallion fund or something.