Section 2 - FTSE

THE VALUE PLAY OF 130/30 STRATEGIES
78
THE 130/30 PRIMER: WHAT YOU NEED
TO KNOW & A LITTLE BIT MORE
What is 130/30 investing?
The idea is simple. Start with a long portfolio tied to
a benchmark, but give managers room to exploit
stocks identified as dogs by selling short up to 30%
of the portfolio and let them reinvest the proceeds in
expected winners. The net market exposure remains
100% (130% long and 30% short), explains Jeremy
Baskin, global head of active quant strategies at
Northern Trust Global Investors (NTGI) in Chicago. A
successful stock picker should deliver better
performance relative to a benchmark while still
subject to the constraints typical of a long only
mandate, including maximum variance from
benchmark weightings by sector, industry and
individual security. “I think that 130/30 has become
a category reference that includes funds that similarly
net to 100% long,” notes Baskin, “it may not be
right for every investor.” Even so, for the right
investor, 130/30 strategies offer investors a lot of
flexibility. “130/30 removes the constraint on shorts,”
he says.
Is this a new strategy?
It has been around for three or slightly more
years and is sometimes referred to as active
extension or short extension strategies. It is
picking up in popularity quite quickly though and
as of March this year it is estimated that between
$50bn and $60bn worth of assets are invested in
130/30 strategies.
Why 130/30 funds are popular
There is a significant demand from the institutional
market. Pension funds, for example, show a
growing need for alpha-based returns to help
solvency levels. 130/30 strategies also offer an
alternative to those institutions for which pure hedge
fund plays are a little to rich for their liking. 130/30
strategies are attractive because they work around
the usual constraints placed on managers by long
only mandates. “Most managers in this regard have
a benchmark and benchmarks are cap weighted,”
says Baskin, adding, “By definition, if you have a
long only mandate, you simply cannot short.
Therefore, the moderate leverage and shorting
that 130/30 allows means that it is attractive to
beneficial owners, which might be wary of jumping
on the hedge fund bandwagon. The appeal of
130/30 is augmented by the fact that they are
cheaper than hedge funds as well.”
While many beneficial owners are looking to
alternative investments, such as hedge funds and
private equity funds for some of this alpha, up to
now actual allocations to these types of
investments as a percentage of overall assets
under management are still very low. The biggest
bulk of corporate plan assets (over 41%) and
public plan assets (over 45%) are in domestic
equities. Most of these investments are in large
cap stocks, which cuts to the heart of 130/30
investing, as it is principally centred in the large
cap segment.
Additionally, UCITs III provide investment
managers with an opportunity to package these
funds for retail investments. While UCITs III funds
do not borrow stocks to sell, they do use
derivatives to gain the same effect.
Baskin says plans can replicate 130/30 exposure
with equitised long/short strategies, such as investing
in market neutral hedge funds and combining that
exposure with a swap on the S&P 500, or a futures
contract to gain particular market exposure.
Why 130/30 and not 140/40 or 150/50?
It is worth noting that 130/30 is not necessarily a set
ratio. Some managers prefer anything from 120/20
to 140/40 or range between. However, in a 130/30
fund the active risk is similar to traditional long only
fund, although the overall exposure to an investment
manager’s investment process is 160%. However, as
NTGI’s Baskin notes, “130/30 strategies are about
getting more alpha per unit of risk. However, if you
look at the maximum value of going short, after
140/40 and 1510/50, the benefits generally
diminish, so you have to have the right balance that
works for your process, benchmark and level of
active risk.”
Why are so many investment banks
beginning to offer 130/30 support?
Not everyone who wants to launch a 130/30 fund
will have the appropriate technology, operational
processes or culture to support the strategy (strange
though it may appear, not all fund managers are
adept at shorting stock, for example). Prime brokers,
for example, while expensive, do offer constructive
help in this regard offering both broking and
custodial services. Equally, banks offering quant
services can help the asset manager identify over or
under priced stocks.
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS