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Mutual Fund News

For mutual fund industry, 130/30 is the new black

MUTUAL FUNDS REPORTER

Institutional money managers are adding a new catch phrase to their vocabulary -- 130/30.

It refers to an asset allocation strategy that is sweeping through the U.S. and gaining more traction in Canada. It is viewed as the most efficient means to tap the hedge fund market and maximize coveted "alpha," that is, performance or profit that exceeds a benchmark.

In a nutshell, 100 per cent of the portfolio is invested in long-only equities. An additional 30 per cent is borrowed and weighted in short positions, bets that the value of some stocks will fall. And finally, another 30 per cent is leveraged exposure in long-only stocks. The strategy is winning favour with so-called quant money managers who rely on computer modelling to build portfolios.

The method "creates a high conviction portfolio, financed in part by shorts," Merrill Lynch said in a portfolio management report released yesterday. The New York investment dealer estimates $50-billion (U.S.) of the estimated U.S. pension market is held in 130/30 portfolios.

"You can think of it as hedge fund -- light. It's a means for someone to dip their toe into hedge fund waters," said Tristram Lett, the deputy chairman of the Alternative Investment Management Association of Canada. Canadian institutional interest in 130/30 has been rising dramatically since last fall, he said.

Long-only managers are "constrained" by the market and retail investors should look for alternatives, said Jamie Colliver, a principal with Putnam PanAgora Integra Canada of Oakville, Ont. "130/30 strategies . . . allow investment managers to use their considerable stock ranking systems to the fullest and that is why retail investors and institutions pay active management fees after all," he said.

The strategy prompted mixed reviews from financial advice firms catering to retail investors. Joe Canavan, chairman and chief executive officer of Toronto's Assante Wealth Management Ltd., described 130/30 as "pretty interesting and a smart strategy" for the right investor.

"In a good market, you should do very, very well as you get higher rates of return from your long-only stocks . . . and in a bad market, you are getting downside protection with higher-quality stocks and an increased capital gain out of the dogs," Mr. Canavan said.

But Chris Reynolds, president of Mississauga, Ont.-based Investment Planning Counsel Inc. cautioned there is no "magic bullet to slay the risk demon."

Retail offerings using the 130/30 formula are likely "a long way off," said Jim McGovern, chief executive officer of Arrow Hedge Partners Inc.

Funds that apply leverage and hedge fund strategies can only be sold to so-called sophisticated investors. Rules vary among provinces, but sophisticated investors are generally those who can invest a minimum of $150,000 in an offering or have assets of at least $1-million.

© 2007 The Globe and Mail. All rights reserved.

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