One of the most discussed developments in the asset management industry is the growing interest among pension schemes in 130/30 funds. In early 2008, more than 20% of public pension funds and 13% of corporate pension plans were invested in 130/30 strategies, according to a Merrill Lynch survey, one of the most comprehensive to date.

The majority of 130/30 assets among these respondents were invested in large cap US equity, with quantitative equity leading the charge, followed by fundamental, and a relatively smaller percentage in quantitative non-US equity. The survey, which covered 160 institutional investors, was conducted before the current market turmoil, during which quantitative funds have been especially hard hit.

It is still early to measure the full impact of US market regulators’ decision late last week to place a ban on short-selling financial stocks. The Swiss securities regulator and most EU member states have taken similar steps, including UK, France and Netherlands. Others are in the process of doing so, prompting 130/30 funds to re-assess their investment approach. The restrictions are likely to stay in place for at least three months.

“The bans will make it more difficult to implement long/short equity strategies, even if there is no evidence to suggest that shorting bans are sensible or effective,” says Giles Conway-Gordon, Managing Partner at Cogo Wolf Asset Management. “There are still substantial negative news to come out concerning mortgages and other forms of debt, even with the Treasury’s underpinning. The timing of any recovery looks very uncertain.”
 

350bps above S&P 

AHL, the flagship hedge fund at Man Group, is no longer trading financial stocks in its long-short portfolio. Yet until recently, a number of factors supported the growing interest in long/short equities, including a reduction in the overall volatility of a fund’s equity allocation. A 130/30 strategy removes the long-only constraint and allows managers to short a percentage (for example, 30%) of their portfolio on which they have a negative view. The proceeds from the short sale are used to purchase an additional 30% in long positions. As a result, a 130/30 portfolio is long 130% , short 30% with a net exposure of 100%, thereby maintaining a beta close to one.

The case for 130/30 is supported by research (Emrich) showing that the alpha available from long-only strategies has declined in the 21^st century. When considering longer periods, 130/30 strategies have outperformed the S&P by 350bps. Johnson, Ericson and Vrimurthy have back-tested 130/30 performance and reached similar conclusions to other studies, including one by Lo and Patel (2008).

In the first quarter of 2008, 130/30 quantitative strategies (which account for 80-85% of market share) under-performed the S&P 500, according to a Man Investments study.  “Perhaps the rigorous back-testing which forms the cornerstone of quant investing is now proving a burden,” notes Robert Buckland, Global Equity Strategist at Citigroup London. “Nothing gets included in the model unless it back-tests strongly. But if everyone back-tests the same data, they will probably end up with the same strategy.” What has changed in the past year is that “investors have stopped picking on just quantitative funds and are now picking on everyone,” says Buckland.

Since August 2007 the volatility outbreak in quantitative strategies has prompted investors to seek greater diversity in their 130/30 investments, possibly dividing their mandates between fundamental and quantitative managers. “We believe this trend toward greater balance in the product space will continue, with fundamental managers working closely with their quantitative counterparts during the next few years,” according to a recent Institutional Investor report. A product specialist at State Street Global Advisors concedes that there has been a slight shift in favour of fundamental strategies, however, he points out that a prolonged market downturn would impact all 130/30 strategies, not just quantitative funds, which he contends should maintain their market share relative to fundamental 130/30 strategies.

Investors who are likely to follow a 130/30 strategy tend to have adopted long ago a core/satellite approach and have progressively reduced their exposure to benchmark +2% strategies, opting for a passive and clearly unconstrained profile, according to bfinance research. They have typically invested in hedge funds, both multi-strategy FOHFs and single hedge funds.

VB