PHILADELPHIA — More mutual fund companies soon will offer individual investors access to a strategy that is popular among institutional investors who are trying to outperform a benchmark.
New York Life Investment Management LLC plans to open its MainStay 130/30 Core Fund and its MainStay 130/30 Growth Fund to retail investors July 2. It also plans to launch an internationally oriented 130/30 fund by Aug. 31.
Other fund companies with 130/30 funds in registration include
BlackRock Inc. and Dreyfus Corp., both based in New York.
Here’s how it works: 100% of the portfolio is invested in a basket of stocks. The manager then sells short an additional 30% in stocks that are expected to underperform. The proceeds of the short sale are then used to extend the portfolio’s long position to 130%.
Currently, there is only one such fund — the $11 million ING 130/30 Fundamental Research Fund — available to retail investors. ING Investments LLC of New York launched that fund in April.
Others fund companies are contemplating whether to introduce 130/30 funds of their own.
“I’ve heard up to a dozen fund companies right now are incubating these products,” said Jeff Tjornehoj, a Denver-based senior research analyst with Lipper Inc. of New York. “I wouldn’t be surprised if they start to roll them out one on top of the other.”
Although
Charles Schwab Corp. has no immediate plans to launch a 130/30 fund, “I’d love to do it,” said Evelyn Dilsaver, executive vice president at the San Francisco discount broker, and president and chief executive of
Charles Schwab Investment Management Inc.
Tough to explain
That said, retail investors may not be ready for 130/30 funds, she said.
“You have to really figure out how to explain it,” Ms. Dilsaver added.
Explaining the strategy can be a challenge, conceded Steve Landau, a managing director and head of product development at Parsippany, N.J.-based NYLIM.
That is one reason that the company plans to spend a lot of time on education, he said.
But once the strategy is understood, acceptance should come easily, Mr. Landau said.
In a market where “modest” returns are expected, the promise of excess alpha may give 130/30 funds an edge, he said.
It is a promise that institutional investors apparently believe.
They have allocated more than $65 billion to 130/30 programs, according to research from Morgan Stanley of New York. That could grow to as much as $500 billion within five years, according to the firm.
Some skepticism
But several financial advisers and industry experts said that they are skeptical about the idea that 130/30 funds will catch on.
“I’m going to assume that with the extra return, there’s more volatility and risk,” said Stephen Gorman, president of Gorman Financial Management Inc. in Hingham, Mass. “It’s not something I would see myself directing many clients towards.”
The only clients for which such funds might be suitable are those with long-term horizons and an appetite for risk, said James Kibler, president of Eldridge Financial Planning LLC of New York.
“These things will probably do well until the market starts going down,” he said. “Then you’ll see their returns go down more than the market.”
Returns would go down if the market headed south, but not necessarily any more so than the market itself, Mr. Landau said. If the market experienced a severe downturn, however, a 130/30 fund would probably underperform its benchmark, he said.
But 130/30 funds aren’t supposed to be used as hedging vehicles, Mr. Landau said. In the case of NYLIM’s expected funds, the net investment is 100% exposure to the equity benchmark.
That doesn’t mean, however, that they are any riskier than long-only funds, Mr. Landau said.
From an asset allocation perspective, risk is best measured by its tracking error — that is, how much a fund deviates from its benchmark, he said. In that respect, 130/30 funds aren’t any riskier than long-only funds, Mr. Landau said.
While there can be additional risks associated with shorting, they can be mitigated, he said.
For example, the risk of experiencing unlimited losses as a result of short positions is minimized in a 130/30 fund that is properly diversified, Mr. Landau said.
Of course, that assumes that an asset manager is qualified to be shorting stocks in the first place — something that isn’t necessarily the case for those managers that offer long-only mutual funds, according to some industry experts.
There are serious concerns that long-only managers — which most mutual fund advisers are — may not have the “talent” to identify short-selling opportunities, said Geoff Bobroff, a fund industry consultant based in East Greenwich, R.I.
It is a valid concern, Mr. Landau said. And it is one of reason that most 130/30 strategies are quantitative, he said.
That is the case at NYLIM, where managers are already overweighted or underweighted in stocks, based on a quantitative ranking, Mr. Landau said. It is fairly simple to apply that process to a 130/30 strategy to determine which stocks to short, he said.
