Quantitative investment strategies that maintain consistent long and short exposures, commonly known as 130/30s, are hot.
New research, however, suggests that it may be a mistake to maintain a fixed short position.
In a 130/30 product, a manager shorts 30% of the portfolio and uses the proceeds to go long an extra 30% in areas where growth is predicted.
Institutional investors have been flocking to such strategies — predominantly within separate ac-counts and collective trusts — in recent years, pumping an estimated $80 billion to $100 billion into them in the past several years, said Steven Deutsch, director of separate accounts at Morningstar Inc. of Chicago.
The strategy has generated so much buzz that mutual funds are trying to get in on the action.
In July, New York Life Investment Management LLC opened its MainStay 130/30 Core Fund and its MainStay 130/30 Growth Fund to retail investors. The company did the same with its MainStay 130/30 International Fund in August.
Other fund companies with 130/30 funds in registration include
BlackRock Inc. and Dreyfus Corp., both based in New York.
But given market fluctuation, maintaining a fixed short exposure might not make sense, according to a report released this month by Los Angeles-based Analytic Investors Inc.
"The most effective long/short approach is likely to be one that allows the long/short target to change over time," according to the report.
To some extent, money managers realize this and generally adjust their short positions up and down within a broad 130/30 strategy, according to Harindra de Silva, president of Analytic Investors.
Mutual fund managers, however, may find that their hands are tied when it comes to extending their short positions, he said.
Under current regulations, a fund could go up to 150/50, but doing so could prove difficult be-cause it involves taking additional risk that retail investors may not understand.
That poses a particular problem for mutual funds that employ 130/30 strategies, because in some cases, a higher short extension may be the best way to optimize returns, ac-cording to the report.
That doesn't mean that 130/30 mutual funds are a bad idea, Mr. de Silva said, noting that they give investors access to an increasingly popular strategy that otherwise might not be available.
"In five years, this type of strategy will be the norm," he said.
It isn't hard to see why.
The 130/30 products performed well during the August market volatility, Mr. Deutsch said.
In analyzing the performance of 38 of the 74 separate-account strategies and registered 130/30 funds tracked by Morningstar — a number that has since increased to 88 — he found that the average return for August was flat.
That compares with a 1.5% return by the Standard & Poor's 500 stock index and a 1.6% average decline for the comparable hedge funds in Morningstar's
hedge fund database.
Such performance shows that 130/30 products performed as advertised, providing investors with a measure of downside protection.
But Mr. Deutsch said that August results prove little.
Such products need to get a few more years of performance data before investors can definitively judge whether adding them to a portfolio makes sense, he said.
Financial advisers feel the same way.
"The proof will be in the pudding at the end of a few years," said Andrew Benedict, director of re-search at MACRO Consulting Group LLC of Parsippany, N.J. "But at this point, [130/30 products] are not something we are screening for."
Although 130/30 managers claim that shorting a portion of their portfolio reduces risk, Derek Imes, president of Principia Investment Advisors LLC in Bogart, Ga., doesn't see it that way.
Shorting stocks requires a certain skill set that isn't the same as the skills required to buy stocks, he said.
And given the fact that there is no limit to losses on short positions, finding the right manager with the right skills becomes even more important, Mr. Imes said.
"More and more managers are rolling them out, but in my opinion, [130/30 products] haven't been around long enough," he said.
David Hoffman can be reached at [email protected].
