Abstract
Several characteristics of a firm and its past return have been shown to be useful in predicting future returns, leading to long-short trading strategies with positive expected return using no invested capital. I develop the idea of active portfolios, which treat these long-short strategies as investable assets. I show that, since the returns from these long-short strategies are largely uncorrelated, active portfolios which make simultaneous bets on several long-short strategies have Sharpe ratios several times that of the market and extremely attractive return characteristics. I argue that this is because the diversification achievable in active portfolios exceeds that attainable through traditional sources of diversification.
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