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Can 130/30 outperform long-only funds?

10/02/2008

Lee Munder Capital Group, with more than $4bn in assets under management, has back-tested 130/30 strategies in one of the first empirical comparisons with long-only strategies. The conclusion? They outperformed long-only funds from January 1994 through December 2006. The domestic and international long-only strategies generated annualised active returns of 7.6% and 7.3%, respectively, while the 130/30 produced returns of 11%. "The results provide additional evidence that allowing a reasonable amount of shorting and re-investing those proceeds in additional long positions can substantially enhance investment returns," according to the report. The analysis covers a domestic universe corresponding to the Russell 1000 Index and an international selection that approximates the MSCI EAFE Index. While both strategies outperformed their respective benchmarks, 130/30 outperformed the long only strategy; however, the risk of the former is 1.2x greater than that of the latter. Gordon Johnson, who heads the quantitative team at Lee Munder, Shannon Ericson and Vikram Srimurthy, authored the study. The historical time-series they analysed includes the technology bubble of the late 1990s and the years following its burst in 2000. "This should not hinder our conclusion, since there are a reasonable number of years included in the sample period before and after the bubble. In addition, this time period provides a good test of 130/30 strategies and the effectiveness of shorting during a market bubble and its aftermath." The study considered long-only portfolios that held an average of 110 stocks, and 143 long and 42 short positions for the 130/30 strategy. Over the study period, longs contributed 9.1% of excess returns, while shorts added an additional 2.1%. The worst years for 130/30 returns from long positions were 1998 and 1999. The worst years for shorts were 2003 and 2004. Since the second half of 2007 quantitative strategies have underperformed long-constrained bets. "With 130/30 you are leveraging alpha," says Johnson. "That is to be expected in the current environment. We do not agree that 130/30 will provide higher returns for less risk. What we have shown is how the strategy has behaved over a longer period of time." VB

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