Section 2 - FTSE

THE VALUE PLAY OF 130/30 STRATEGIES
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Ric Thomas, a senior managing director of State Street Global
Advisors (SSgA) and department head of the US enhanced equity
group, estimates that at any particular time only 10 or 15 names in
the Russell 1000 are specials subject to higher borrowing costs.
Even for the small capitalisation Russell 2000 Index, he reckons
85% of the names are general collateral. With so much scope for
shorting general collateral stocks, 130/30 managers either avoid
specials altogether or take small positions in just a few names.
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.”
team provides advice, analysis, prime broker and securities
lending services to managers who run 130/30 portfolios.
Although Darrell Riley, head of global institutional
marketing at T. Rowe Price, accepts the logic behind 130/30
structures he remains leery of its practical application,
particularly for fundamental managers who often lack the
quantitative tools and risk management systems needed to
handle a short book. He notes that short positions
consume a disproportionate share of a manager’s
emotional energy, too. “It’s the exception rather than the
rule that people are good at it,” Riley says. T. Rowe Price
does not offer 130/30 portfolios today and has no
immediate plans to do so.
Riley sees 130/30 products positioned as high conviction
long strategies with selective use of shorts to capture the
full benefit of a manager’s research knowledge. On the
quant side, it works remarkably well for as long as the
quantitative model works.“Quants are fine when there is
good factor stability and when you combine that with
130/30, it’s fantastic,” Riley says, “But when there is a
turning point, they may really suffer.” It’s no secret that
quantitative 130/30 managers hit a rough patch during the
market turmoil in July and August.
Track records in 130/30 are still short, but so far, UBS,
which has $2.25bn under management, has delivered
about double the excess return of its long only portfolios.
From inception in September 2005 through the end of
June, its institutional 130/30 product is up 17.93%,
compared to 15.76% for the equivalent long only
portfolio and 14.32% for the Russell 1000, the benchmark
for both. At 4.33%, the tracking error has come in at the
low end of the 4%-8% target range, which Bondurant
attributes to unusually low market volatility through
most of the period.
Investors don’t get a free lunch, however. 130/30
portfolios bear incremental transaction costs because they
deploy 60% more capital and have correspondingly higher
portfolio turnover. Managers charge higher fees, too. For
its retail 130/30 product, UBS charges 150bps—about
35bps more than for the equivalent long only vehicle.
Institutional fees are lower, of course, but 130/30 products
still command a 45% premium over long only fees. The
portfolios incur stock borrowing and financing costs, too,
which Bondurant estimates at 15bps provided almost all
the shorts come from the general collateral pool. On
balance, a retail UBS investor pays an extra 50bps for a
shot at up to 300bps of excess return.
Borrowing from the hedge fund world, institutional
130/30 fees often include a performance element although
it typically doesn’t kick in unless the manager beats the
benchmark return. 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- 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.
So far, most 130/30 products are benchmarked to broad
indices, including the MSCI World, the Standard & Poor’s
500 and the Russell 1000. For large capitalisation indices
like these, even the smaller names a 130/30 manager might
want to sell short are usually available in the general
collateral pool.
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS