130-30 fund
Encyclopedia
A 130-30 fund or a ratio up to 150/50 is a type of collective investment vehicle, often a type of specialty mutual fund
, but which allows the fund manager simultaneously to hold both long and short positions on different equities in the fund. Traditionally, mutual fund
s were long
-only investments. 130-30 funds are a fast growing segment of the financial industry, with many new releases planned in 2008 ; they should be available both as traditional mutual funds, and as exchange-traded fund
s (ETFs). While this type of investment has existed for a while in the hedge fund
industry, its availability for retail investors is relatively new.
A 130/30 fund is considered a Long-Short Equity Fund
, meaning it goes both long and short at the same time. The "130" portion stands for 130% exposure to its long portfolio and the "30" portion stands for 30% exposure to its short portfolio. The structure usually ranges from 120/20 up to 150/50 with 130/30 being the most popular and is limited to 150/50 because of Reg T
limiting the short side to 50%.
The 130-30 funds work by investing, say, $100 in a basket of stocks. They then short $30 in stocks that they believe to be overvalued. Proceeds from that short sale are then used to purchase an additional $30 in stocks thought to be undervalued. The name reflects the fact that the manager ends up with $130 invested in traditional long positions and $30 invested short. A common strategy is to use a traditional index, such as the Standard & Poor
or NASDAQ 100
, and then rate the stocks comprising that index by a proprietary method; the top stocks would be held long, the bottom stocks short.
benchmark and has a 100 percent exposure to the market. Therefore, a 130-30 strategy’s performance should be evaluated similar to a long-only strategy and compared to its benchmark. Market exposure is also called beta, and 100 percent exposure equals a beta of one. For this reason both long-only and 130-30 are often referred to as beta-one strategies. In contrast, hedge funds with a marketneutral long-short strategy, by definition, have a beta of zero. Secondly, 130-30 funds are typically regulated under the jurisdiction of traditional investment funds, and for this reason they are allowed to market themselves to the general public. This, in combination with the fact that the risk and
return profile of 130-30 structures is similar to the long-only framework, makes them suitable to attract long-only money.
The primary purpose of the 130-30 funds is to tap into the large pool of assets allocated to long-only managers, while the primary rationale of the strategy is to attempt to construct more efficient portfolios by allowing limited short selling. The world’s 500 largest long-only fund managers have a total of assets under management of $63.7 trillion. In comparison global hedge fund assets are estimated to $2.48 trillion, or 3.9 percent of that. It is obvious that the long-only funds manage a large chunk of money that everyone is interested in. The global assets of 130-30 funds are in perspective very small, approximately $53.3 billion. Nevertheless, the fund segment is growing rapidly; assets increased with 78.5 percent over the first nine months of 2007. The fee structure of 130-30 funds is, as mentioned above, closer related to that of hedge funds than that of long-only funds. In general, the performance fee is on average very similar to the hedge fund average, while the management fee is typically lower, and in-between long-only and hedge funds.
from the short leg than it is better to invest into a 130-30 strategy rather than a long-only strategy. However, if one believes, that the manager cannot generate alpha from short selling or that the higher gross exposure of a 130-30 fund is unbearable, then one should invest into a long-only strategy.
The greater part of hedge funds describe themselves as market neutral long-short equity strategies. The purpose of all market neutral long-short funds is to run an absolute-return strategy. Consequently, the aim of the investment strategy is to produce profits regardless of market direction. Many hedge funds and market neutral long-short funds were started following the last bear market from 2000-2002, endorsed by a prolonged bear market that sparked interest in absolute returns and the separation of alpha and beta management. The worldwide growth in hedge funds was driven by three factors: the equity bear market; investor interest in absolute returns due to heavy losses and the flow of top talent into those hedge funds notching up absolute returns. Typically, market neutral long-short funds will have a beta exposure between 30 percent net long
to 10 percent net short. Since market neutral long-short returns often move in a different direction from the overall market, it can help investors to diversify their portfolios. In neutral or bear market scenarios, the advantages of market neutral long-short are prevailing. In bull markets, market neutral long-short strategies tend not to be able to generate better returns than other investment strategies. In comparison, it would be advantageous to invest into a 130-30 fund in a strong bull market. The main obvious similarity between these strategies and 130-30 is that both strategies
have both long and short positions. Market neutral hedge funds typically charge a performance fee, inline with most 130-30 funds. On the other hand they are not managed to an index, but instead use the risk-free interest rate
as their benchmark.
The holy grail of alpha hunting and absolute returns is a zero sum game, producing winners and losers. A fact that often seems to be overlooked is that performance fees, besides aligning the interest of fund managers with investors, also attain top talent. Since alpha is difficult to extract, the single most important factor of active management is the talent of the fund manager. According to a hedge fund survey in 2005, the three key risks for the fund segment is overcrowding, poor returns and mis-pricing. In effect, the argument is that due to overcrowding the alpha available for capture by hedge funds has to
spread over more funds, resulting in lower returns. Furthermore, the study concluded that two in three pension funds believe that worldwide overcapacity will drive down the returns. One should underline that these risks are also noteworthy for 130-30 strategies. As an asset class hedge funds have recorded an annual return of 10.7 percent since 1994, according to CSFB/Tremont, which tracks about 400 hedge funds. That is marginally ahead of Standard & Poor’s 500 annual gains over the period of 10.4 percent. In this perspective, beta seems to offer rather attractive risk-adjusted returns over time. Conclusively, one could argue that it might be desirable to invest in a strategy that can offer both beta and the potential upsides of long-short strategies in terms of alpha generation. Nevertheless, 130-30 is first and foremost not competing with market neutral long-short funds as an investment vehicle. Instead, they should be viewed as an alternative to long-only funds, where managers can use short selling as a possible additional source of alpha.
Mutual fund
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors to buy stocks, bonds, short-term money market instruments, and/or other securities.- Overview :...
, but which allows the fund manager simultaneously to hold both long and short positions on different equities in the fund. Traditionally, mutual fund
Mutual fund
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors to buy stocks, bonds, short-term money market instruments, and/or other securities.- Overview :...
s were long
Long (finance)
In finance, a long position in a security, such as a stock or a bond, or equivalently to be long in a security, means the holder of the position owns the security and will profit if the price of the security goes up. Going long is the more conventional practice of investing and is contrasted with...
-only investments. 130-30 funds are a fast growing segment of the financial industry, with many new releases planned in 2008 ; they should be available both as traditional mutual funds, and as exchange-traded fund
Exchange-traded fund
An exchange-traded fund is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE...
s (ETFs). While this type of investment has existed for a while in the hedge fund
Hedge fund
A hedge fund is a private pool of capital actively managed by an investment adviser. Hedge funds are only open for investment to a limited number of accredited or qualified investors who meet criteria set by regulators. These investors can be institutions, such as pension funds, university...
industry, its availability for retail investors is relatively new.
A 130/30 fund is considered a Long-Short Equity Fund
Stock fund
A stock fund or equity fund is a fund that invests in equities more commonly known as stocks. Stock funds are contrasted with bond funds and money funds. Fund assets are typically mainly in stock, with some amount of cash, which is generally quite small, as opposed to bonds, notes, or other...
, meaning it goes both long and short at the same time. The "130" portion stands for 130% exposure to its long portfolio and the "30" portion stands for 30% exposure to its short portfolio. The structure usually ranges from 120/20 up to 150/50 with 130/30 being the most popular and is limited to 150/50 because of Reg T
Regulation T
Federal Reserve Board Regulation T is 12 CFR §220 - Code of Federal Regulations, Title 12, Chapter II, Subchapter A, Part 220 ....
limiting the short side to 50%.
The Mathematics of 130-30
The 130-30 funds also known as 1X0/X0 funds give ordinary investors a taste of an investing strategy that has been popular among hedge funds, lightly regulated investment pools for institutions and rich individuals. Like other "long-short" mutual funds, the 130-30 funds have traditional "long" holdings of stocks but also sell other stocks "short" in a bet that prices will fall. In a short sale, investors sell borrowed shares with the hope of repurchasing them later at a lower price.The 130-30 funds work by investing, say, $100 in a basket of stocks. They then short $30 in stocks that they believe to be overvalued. Proceeds from that short sale are then used to purchase an additional $30 in stocks thought to be undervalued. The name reflects the fact that the manager ends up with $130 invested in traditional long positions and $30 invested short. A common strategy is to use a traditional index, such as the Standard & Poor
S&P 500
The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large-cap common stocks actively traded in the United States. The stocks included in the S&P 500 are those of large publicly held companies that trade on either of the two largest American stock...
or NASDAQ 100
NASDAQ-100
The NASDAQ-100 is a stock market index of 100 of the largest non-financial companies listed on the NASDAQ. It is a modified capitalization-weighted index. The companies' weights in the index are based on their market capitalizations, with certain rules capping the influence of the largest components...
, and then rate the stocks comprising that index by a proprietary method; the top stocks would be held long, the bottom stocks short.
What are 130-30 Active-extension funds?
130-30 strategies share three investment techniques with hedge funds; they are allowed to use short selling, they are leveraged vehicles and they typically have a performance-linked compensation. There are also vast differences, firstly they do not seek absolute returns regardless of the performance of the market. Instead 130-30 strategies aim at outperforming an index or another benchmark just like a traditional investment fund. Johnson et al. (2007) argue that despite the similarities to hedge funds, a 130-30 strategy is more like a long-only strategy because it is managed to abenchmark and has a 100 percent exposure to the market. Therefore, a 130-30 strategy’s performance should be evaluated similar to a long-only strategy and compared to its benchmark. Market exposure is also called beta, and 100 percent exposure equals a beta of one. For this reason both long-only and 130-30 are often referred to as beta-one strategies. In contrast, hedge funds with a marketneutral long-short strategy, by definition, have a beta of zero. Secondly, 130-30 funds are typically regulated under the jurisdiction of traditional investment funds, and for this reason they are allowed to market themselves to the general public. This, in combination with the fact that the risk and
return profile of 130-30 structures is similar to the long-only framework, makes them suitable to attract long-only money.
The primary purpose of the 130-30 funds is to tap into the large pool of assets allocated to long-only managers, while the primary rationale of the strategy is to attempt to construct more efficient portfolios by allowing limited short selling. The world’s 500 largest long-only fund managers have a total of assets under management of $63.7 trillion. In comparison global hedge fund assets are estimated to $2.48 trillion, or 3.9 percent of that. It is obvious that the long-only funds manage a large chunk of money that everyone is interested in. The global assets of 130-30 funds are in perspective very small, approximately $53.3 billion. Nevertheless, the fund segment is growing rapidly; assets increased with 78.5 percent over the first nine months of 2007. The fee structure of 130-30 funds is, as mentioned above, closer related to that of hedge funds than that of long-only funds. In general, the performance fee is on average very similar to the hedge fund average, while the management fee is typically lower, and in-between long-only and hedge funds.
Comparison with other investment vehicles
The trade-off between long-only, 130-30 and market neutral long-short funds depends on two factors: 1) If one has a neutral or negative market view and does not want any beta exposure, then one should invest into a market neutral long-short hedge fund. However, if one has a positive market view and wants beta exposure, then one should invest into either a long-only or 130-30 strategy. 2) If one believes that the fund manager can generate alphaAlpha (investment)
Alpha is a risk-adjusted measure of the so-called active return on an investment. It is the return in excess of the compensation for the risk borne, and thus commonly used to assess active managers' performances...
from the short leg than it is better to invest into a 130-30 strategy rather than a long-only strategy. However, if one believes, that the manager cannot generate alpha from short selling or that the higher gross exposure of a 130-30 fund is unbearable, then one should invest into a long-only strategy.
The greater part of hedge funds describe themselves as market neutral long-short equity strategies. The purpose of all market neutral long-short funds is to run an absolute-return strategy. Consequently, the aim of the investment strategy is to produce profits regardless of market direction. Many hedge funds and market neutral long-short funds were started following the last bear market from 2000-2002, endorsed by a prolonged bear market that sparked interest in absolute returns and the separation of alpha and beta management. The worldwide growth in hedge funds was driven by three factors: the equity bear market; investor interest in absolute returns due to heavy losses and the flow of top talent into those hedge funds notching up absolute returns. Typically, market neutral long-short funds will have a beta exposure between 30 percent net long
to 10 percent net short. Since market neutral long-short returns often move in a different direction from the overall market, it can help investors to diversify their portfolios. In neutral or bear market scenarios, the advantages of market neutral long-short are prevailing. In bull markets, market neutral long-short strategies tend not to be able to generate better returns than other investment strategies. In comparison, it would be advantageous to invest into a 130-30 fund in a strong bull market. The main obvious similarity between these strategies and 130-30 is that both strategies
have both long and short positions. Market neutral hedge funds typically charge a performance fee, inline with most 130-30 funds. On the other hand they are not managed to an index, but instead use the risk-free interest rate
Risk-free interest rate
Risk-free interest rate is the theoretical rate of return of an investment with no risk of financial loss. The risk-free rate represents the interest that an investor would expect from an absolutely risk-free investment over a given period of time....
as their benchmark.
The holy grail of alpha hunting and absolute returns is a zero sum game, producing winners and losers. A fact that often seems to be overlooked is that performance fees, besides aligning the interest of fund managers with investors, also attain top talent. Since alpha is difficult to extract, the single most important factor of active management is the talent of the fund manager. According to a hedge fund survey in 2005, the three key risks for the fund segment is overcrowding, poor returns and mis-pricing. In effect, the argument is that due to overcrowding the alpha available for capture by hedge funds has to
spread over more funds, resulting in lower returns. Furthermore, the study concluded that two in three pension funds believe that worldwide overcapacity will drive down the returns. One should underline that these risks are also noteworthy for 130-30 strategies. As an asset class hedge funds have recorded an annual return of 10.7 percent since 1994, according to CSFB/Tremont, which tracks about 400 hedge funds. That is marginally ahead of Standard & Poor’s 500 annual gains over the period of 10.4 percent. In this perspective, beta seems to offer rather attractive risk-adjusted returns over time. Conclusively, one could argue that it might be desirable to invest in a strategy that can offer both beta and the potential upsides of long-short strategies in terms of alpha generation. Nevertheless, 130-30 is first and foremost not competing with market neutral long-short funds as an investment vehicle. Instead, they should be viewed as an alternative to long-only funds, where managers can use short selling as a possible additional source of alpha.