How Effective Are the 130/30 Funds and Are They Here to Stay?

Date: Monday, December 10, 2007
Author: Lenny Broytman, Risk Center

There are those in the market jittering behind their computer terminals, softly rocking back and forth while whispering ‘recession’ and there are others celebrating ridiculously healthy daily gains via the Dow Jones.

But as CNNMoney.com points out, it’s the drastic plunges that the market can now truly capitalize on with the use of 130/30 funds CNNMoney says will deliver if the bull begins to slide.

According to the article, the two dozen or so 130/30 funds that have been launched over the course of the last few months employ hedge fund-type strategies and have the potential capability to overpower certain market indexes over an extended period of time… no matter how those indexes perform.

Launched very recently by companies such as ING, MainStay and UBS, these 130/30 funds are also betting against equities. They are achieving this rather simply, by just short-selling a portion of their portfolio.

The idea at play here is rather simple. If a fund manager has the capacity to single out winning stocks, why wouldn’t he do it constantly?

What makes 130/30 funds unique is that they invest via borrowed capital or gain returns thru other means. While some would be quick to say that these funds give managers superpowers, their single claim to fame is that they can do what hedge funds cannot… and that’s invest “long.”

Essentially, for every $100 that a fund manager invests on a collection of stocks he expects to rise, he shorts $30 in stocks he thinks will flounder. After that, the fund manager will take an additional $30 and sink them into stocks he/she believes are set to go up. When this is all over, what the manager then ends up with is a $130 bet on equities for every $30 bet against them. And that is where the term ‘130/30’ comes from.

Since these types of funds have the added advantage of having a net 100 percent exposure to equities, they insist that dealing with them is not any riskier than operating with regular stock funds that do not short.

Unfortunately, the market has yet to be presented with sufficient evidence that these strategies are actually effective. For example, between July 19 and August 15 of this year, when the market saw the S&P drop 8.9 percent, the average retail 130/30 fund fell 11 percent.

"With a 130/30 fund, you're simply upping the stakes in your bet on an active manager," says Rick Ferri, an investment adviser in Troy, Mich. "And there's little reason to believe many managers can successfully beat the market by going long, let alone going short."