Does 130/30 justify the hype?

Australian Financial Review, July 2008

The 130/30 style of investment has caught on among Australian superannuation funds – but hasn’t yet found its way to retail. There are signs, though, of the first mutual funds appearing in Australia using this increasingly popular way of managing money.

130/30 is a type of long-short fund. These are funds in which people can take both long positions – the usual way of investing, in which you make money if share prices go up – and short positions, in which you benefit when they go down.

What’s distinctive about 130/30 is that it is very specific about the weightings for going long and short. The 30 bit is the percentage of the fund that can be used to take short positions, which involves borrowing a stock, selling it, and hoping you can buy it back cheaper at a later date and thus make money on the trade. The money that comes from those short sales is then added to the pool of money the fund manager has to take long positions – hence the 130. The appeal for institutional investors is that, in balance, there’s a constant level of exposure to the market (130 minus 30 equals 100), and because they are getting $160 of trading positions for $100 of commitment.

Fund managers also like the fact that it gives them much more freedom to express their views on the market. Long only managers, in mainstream equity funds, can only act on the stocks they think are going to do well. If they have an equally strong conviction that a fund is going to do badly, there’s nothing they can do about it. Long-short managers can take advantage – but not many people have the skills to get it right.

Big Australian super funds have caught on to this very quickly. Industry funds including Hesta, Hostplus, Care Super and Just Super are known to be using 130/30 mandates, typically going to a clutch of American managers who have been early movers in this style, including Acadian Asset Management, Axa Rosenberg and AQR Capital Management. Hostplus seeded Acadian’s 130/30 strategy in Australia. (Acadian Australia is jointly owned by Acadian Asset Management of the US, and by Colonial First State).

They appeal to big groups partly because they don’t skew their allocations in unpredictable ways, as funds that can take unlimited long and short positions might. It also appeals to funds with the depth of research to have an opinion on many stocks at once. “For quant managers, it makes complete sense,” says Chris Montagu, head of quant analysis at Citi in Sydney. “If you’re a quant manager and you’re investing in the ASX 200, your processes allow you to have a view on every stock. This way, you can construct portfolios efficiently.” He sees growing momentum in Australia. “In the last year in Australia, there has been a huge influx of managers wanting to look at this type of strategy.”

One doesn’t, yet, see a lot of funds calling themselves 130/30 available in Australia, though they are starting to appear. Acadian reaches retail through the FirstChoice platform; and Plato Investment Management, founded by former Perennial chief Ian Macoun in 2006, has an Australian Shares 130/30 Fund available, although its minimum initial investment is $50,000. Strictly speaking, its investment parameters make it a 135/35 fund, and it is important to note that there is nothing magical about the numbers 30 and 130: the point is any fund that takes long and shorts positions which balance each other out to create market exposure of 100% (or, to put it in technical parlance, a beta of one).

BNY Mellon Asset Management also has an Australian equities 130/30 fund available, but only at the institutional level, although in time it is likely to find its way to local small investors through platforms. “It’s really become part of the accepted wisdom that if you’re looking for something a bit more active, it’s more efficient to offer it through a 130/30 structure,” says Don Russell at BNY Mellon. “You’re getting rid of the constraint on the manager of not being able to underweight a particular stock any more than the weight is in the benchmark.”

Do they work? Mercer Investment Consulting compiles a monthly list of long-short funds which, although they are not all 130/30, do all have that market beta of one. Based on Mercer’s May 31 numbers, the median long/short fund beats the median long/only fund over every timeframe from one month to three years, though the range of outcomes can be quite striking: over the last 12 months, between only 17 managers the range goes from Portfolio Partners High Growth at 5.8%, down to SSgA Australian Long/Short Equity Trust with a 7.2% loss.

Fees tend to be higher than on mainstream products. The Plato fund, for example, charges only 0.5% management fee but adds a 15% outperformance fee against the S&P/ASX 200 index (with a high watermark, meaning any losses must be earned back before a new performance fee can be charged). Funds like this are also generally considered aggressive and volatile: Plato sets its target performance rate over five years and wants people to invest with that sort of timeframe in mind.