A while back, Josh Payne and I dived deep into the Acquirer’s Multiple (AM) and compared that to the Magic Formula (MF). Long story short, he found that the AM outperformed the MF by a significant margin.
However, and as is typical for a lot of value investing strategies, both styles embraced the market tidal wave: neither hedged out their positions. So that begged the question, “What would the Acquirer’s Multiple look like if we reduced market risk?”
In other words, how would the AM strategy perform if it was closer to market neutral?
There are a number of ways to answer that question and the simplest way is to enter in an equal short side for whatever long side you have. So if you had a buy for AAPL of $100,000, you would hedge it by shorting $100,000 of the SPY. That can be as simple as
order_value(stock_1, 1000)
order_value(spy, -1000) or as complicated as
#: For order_target users
order_id = order_target_percent(stock_1, .5)
if order_id:
dollar_amt_ordered = get_order(order_id).amount*data[stock_1].price
order_value(spy, -dollar_amt_ordered) In this algorithm, you’ll notice that I don’t take a complete 1-to-1 short side of the SPY but something closer to about 2-to-1. I do this because I wanted to keep my leverage low and am okay with having a beta slightly higher than 0. You can change this yourself in context.hedge_weight.
A cool comparison between the algorithms can be found in the notebook.
If you want to challenge yourself, try taking the attached algorithm (first reply to this thread) and replace my hedging mechanism with a beta-hedge. By that I mean, calculate the 30 day beta of whichever stocks you're buying and use that to calculate your hedge amount. See example here:
Feedback and improvements welcome!
