Section 2 - FTSE

THE VALUE PLAY OF 130/30 STRATEGIES
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benchmark return from diversified
portfolios that minimise risk.“We are
not one of those 130/30 managers
that have really concentrated bets
that are highly deviated from the
benchmark,” says Chiang. Rather
than a separate asset class, he sees
130/30 as a tool that can be applied
to, say, large capitalisation or
international equity mandates,
which accounts for differences in
how managers construct the
portfolios and what fees they charge.
Among the top 130/30 managers
this year is UBS, which has pursued
a fundamental price to intrinsic
value investment approach for more
than 25 years. The firm’s analysts
have always run discounted cash
flow models on the companies they
cover, according to Scott Bondurant,
capability head for long-short equity
products at UBS Global Asset
Management. UBS stock rankings
all the way back to 1980 show that
the most under-priced names
outperformed the market by about
5% and the most overvalued
underperformed by about 3%. UBS
targets an excess return of 200 basis
points (bps) for a long only portfolio
benchmarked to the Russell 1000
Index, but for a similar 130/30
portfolio the firm expects its
leveraged stock selection to deliver
250bps-500bps over the benchmark.
Leverage can cut both ways, of
course. “We believe in active
management,” says Bondurant, “if
you have a manager that doesn’t
have that skill in the first place
130/30 is giving him another shot at
getting it wrong.”
To proponents, the 130/30
structure frees managers to make
more money from stocks they expect
to underperform. In capitalisation
weighted equity indices, a few large
names dominate the list followed by
a long tail of stocks with trivial
weights. For example, Bondurant
says more than 80% of the stocks in
the Russell 1000 have a weighting of
less than 15bps. Long only mandates
that contemplate a maximum
100bps variance from the
benchmark weighting in individual
Brad Taylor, global head of investment finance and
hedge fund services at RBC Dexia, says institutions
are happy to pay for alpha but not for strategies
that only deliver repackaged beta.“Institutions are
looking for the benefit of a long-g- short approach
but they are increasingly seeking this exposure in a
more modest cost structure,”Taylor says. Institutions
like the transparency and controlled risk profile
130/30 portfolios offer, too. Photograph kindly
supplied by RBC Dexia, October 2007.
Warren Chiang, managing director responsible for
active equities strategies at Mellon Capital, a
division of The Bank of New York Mellon
Corporation, restricts variance from benchmark
weight for individual stocks to ±1% and keeps a
tight rein on factor risks to eliminate any bias
toward growth, value or momentum. Such
constraints deliver low tracking error (between 2.5%
and 3%) and a modest excess return target of 2.5%,
which is about 1.5% higher than for the equivalent
long only portfolio. Photograph kindly supplied by
The Bank of New York Mellon, October 2007.
stocks don’t give managers the
flexibility to make that bet against
the smaller names: they can only go
to zero, no matter what the weight.
“If you have a 15bps you identify as
50% overvalued and it
underperforms by 50% then you
have added 7.5 bps,” Bondurant
says, “It is no big deal. However, if
you can go to 85bps short—100bps
less than the benchmark—you add
50bps. That is very meaningful.”
Charles Shaffer, managing
director and product manager for
130/30 in Merrill Lynch’s global
markets and investment banking
division, says quantitative
managers have taken an early lead
in snagging 130/30 mandates,
accounting for more than 70% of
the assets under management. It is
a natural extension of their
investment process, which relies on
factor models to rank stocks from
best to worst. For a long only
mandate, managers buy the top
stocks, but they have a ready-made
list of losers to populate the short
side of a 130/30 portfolio.
Like quants, long only
fundamental managers focus on
picking winners, but they have no
incentive to devote scarce resources
to losers. If a company doesn’t pass
muster, most fundamental analysts
drop it and move on; unlike quants
or shops like UBS, they don’t rank
their entire universe. Fundamental
managers who want to offer 130/30
products have to reorient their
research to generate ideas for the
short book.
Shaffer says sceptics once
claimed that only hedge fund
managers, who know how to
handle shorts, and quants, who
employ rigorous risk management
and a ready ranking of stocks,
would be able to run 130/30 money
well. Experience has proved the
naysayers wrong, however:
fundamental 130/30 managers have
beaten the quants hands down in
2007. “The conventional wisdom,
particularly in the early days of
product development, is often
backwards,” says Shaffer, whose
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS