Quality Minus Junk – The Benefits of Shorting

Most investors are looking for stocks with positive upside. Stocks with downside potential are typically avoided or sold, and depednding on the stock, this can potentially yield returns in excess of the market.

However, in 2013 a few finance academics: Asness, Frazzini, and Pedersen developed a research paper called Quality Minus Junk.

The Quality Minus Junk model was a first of its kind in academic research. Rather than creating some new stock sorting model to find the best bull stocks, these researchers leveraged older strategies such at the CAPM, 3 Factor Alpha, 4 Factor Alpha, Sharpe Ratio and Information Ratio. However, they added a hint of genius and instead of only investing in the largest quintile of stocks like usual, the researchers purchased the top 30% and shorted the bottom 30% of stocks within each model.

They found, by simply shorting the bottom 30% in addition to going long, they were able to earn excessive returns above the normal excess returns of those models.

This confirmed the accuracy of older theories as filtering mechanisms, but also launched a new technique for maximizing returns.

Nowadays, it is possible and quite easy to take a short position on a stock. Options are the most common and accessible way to take a short position in a stock and are easily turned on in the Robinhood Trading app.

However, there are other considerations when trading options as opposed to stocks so be sure to understand options and the time value of money before putting money on the table.

Check out my other research articles to learn more about options or any of the other investment models mentioned in this article.

Leave a Reply

Your email address will not be published. Required fields are marked *