Short Selling Can Yield More Excess Returns, Due to Inefficiencies

One question I get asked a lot on running my long/short strategy is what is the return of my longs versus the return on the shorts, and do I earn a bigger "alpha" on one or the other. Generally the short side earns bigger excess returns, as the thinking goes that since fewer investors short, there is more inefficiency "on the short side", since for most investors the only way to express a negative view on a stock is to either not own it or underweight it relative to a benchmark.

I ran the numbers on my portfolio over the last 6+ months since July. The estimated return on my longs over the period was -12.31%, which though a loss, compares favorably to the -13.62 loss of the S&P 500 during that time, for a slight excess return of roughly 1.3%. My portfolio selects from roughly the top 1500 US stocks, so for an even more appropriate performance comparison, the S&P Composite 1500 was down 14.14% during that time, giving me a 1.8% excess to that benchmark.

My shorts however, fell more than the market. They were down 16.66%, for an "excess return" of basically 3% to the S&P 500, or 2.5% to the 1500. Combining the longs/shorts on price and dividend returns alone gives about 4.3%. Add in the interest earned on the short sale proceeds and take away all the fees and commissions, and the net return for the period is 4.52%.

Not a lot of data so far, but the results are typical for the strategy over the long term - a slight excess from the longs and more excess from the shorts, netting to a respectable total rate of return that's more or less uncorrelated to the stock market.

If you aren't comfortable shorting, then certainly consider my long stock picks, though keep in mind my strategy is geared for shorter term holding periods, roughly 6-9 months, to extract the spread performance of the longs vs. the shorts.