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Year End


Our hedge fund is opportunistic. This simply means that we are not wed to one particular strategy no matter the expected return for risk. We look at cash as an asset: if there is nothing to do, we just put the capital in the bank.

One trade we do almost every year end is to buy a basket of stocks that have underperformed the market against selling S&P futures. We sometimes adjust this portfolio to be beta neutral, although being beta positive often is a better return for higher risk.

I describe this trade for educational purposes, not as a recommendation.

In December many funds sell stocks that have underperformed for the year in order to generate tax losses. They do this to offset capital gains taken against profitable positions during the year. I cringe a little when I think about this for it certainly goes against what I believe is prudent investment policy, but it occurs nonetheless. Ah, the human element in things is not necessarily rational.

The trick is to decide when this tax selling is nearly finished. We have noticed statistically that in the last few years this seems to be occurring a little later in the month of December. So a week or so before the last trading day of the year we begin to build the portfolio.

We then wait. Over the next month or so into early February this basket of stocks usually begins to outperform the market in general as the tax selling stops and then the same funds that sold the stocks out for year end begin to actually buy them back (individual investors as well as funds must wait thirty days to buy these stocks back in order to avoid "wash sale rules").

Year end capital flows should be quite strong given the low interest rates (real rates are actually negative). The human element is not necessarily considering the risk: year end bonus money, not finding much in return in other financial assets, is likely to find its way into stocks no matter how abhorrent it seems to me.
No positions in stocks mentioned.

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