CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

36.3 MECHANICS OF THE STRATEGY

This section discusses the mechanics of the traditional long/short investment process. Though the steps taken by any one manager will vary, essentially all long/short managers begin with an investment idea and end with portfolio risk management.

36.3.1 Idea Generation

The first and by far the most critical step is to generate good investment ideas. Some managers screen the universe of stocks based on fundamental ratios or technical indicators so as to reduce the total number of stocks to a manageable size. Others read industry newsletters, research reports, market commentary, academic research, or other written sources of information to gain investment insights. Additionally, some managers attend investment conferences, trade conferences, and idea luncheons/dinners to develop new ideas. The value of a solid network of colleagues cannot be overestimated in uncovering and refining new ideas. Some may talk to friendly CEOs or CFOs, while others may scrutinize forms required by regulators such as Form 13F reports for ideas. Any source that is publicly available can be employed for idea generation.

36.3.2 Optimal Idea Expression

The next step, instinctive to seasoned long/short managers, involves deciding how to best express an idea—in other words, determining the best investment decisions that can be made based on the investment idea. During this process, the manager may make the following inquiries:

• What trade should be executed to extract the highest ...