Investors stand by 130/30 funds

Date: Friday, May 9, 2008
Author: Phil Craig, Financial News Online

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The credit crisis has taken its toll on the performance of 130/30 funds—which have 130% exposure to long positions and 30% to shorts—but so far investors appear to be giving them the benefit of the doubt.

Most 130/30 funds available to UK investors enjoyed net inflows in the first three months of the year despite of negative returns over the period, according to analysis by Financial News.

A cross-section of UK funds offered by asset managers including JP Morgan, Resolution, Threadneedle and UBS disclosed that most of their UK 130/30 fund returns were negative in the first quarter, according to data provider Morningstar, and many underperformed the relevant equities benchmarks.

However, investors—including retail investors, who are notoriously wary of investing in funds reporting negative returns—still pushed assets into many of the vehicles.

JP Morgan Asset Management is ahead of the pack, with four 130/30 funds available in the UK and a fifth reportedly on the blocks. It distributes two European equities and two US equities funds.

Since the beginning of the year, its four funds have suffered negative returns, according to Morningstar, and one of its European funds has shrunk in size faster than their performance accounts for, suggesting net outflows.

However, its two US funds have not shrunk to the same extent as performance, suggesting net inflows.

Three of the funds have less than €9m ($14m). The fourth fund, the US Select 130/30 fund, has grown from $525m (€340m) at the beginning of the year to $892m at the end of March. This is despite registering losses and underperforming its benchmark in January and March by almost five percentage points.

Threadneedle’s American Extended Alpha fund followed a similar pattern, underperforming the S&P 500 in January and March, but the fund more than tripled in size to £18m (€23m) over the first quarter.

Jonathan Price, a managing director on the US equities desk at JP Morgan Asset Management in London, said: “The fact that investors continue to put money into these strategies is due to the simple reason that the 130/30 tool has both a strong academic logic and practical implementation efficiency."

Investors recognize that any investment process will give fluctuating returns over short term measured periods such as a single quarter.

Price said: “The bad performance from quantitative 130/30 strategies was nothing to do with the 130/30 tool and everything to do with the fact that the underlying processes of those managers involved were severely challenged by events.”

Net inflows from investors, despite negative returns that in some cases underperform their benchmark, suggest investors are paying attention to asset managers’ arguments in favor of 130/30 structures.

The funds short stocks to raise 30% of assets on top of the 100% already invested in the fund. They then use the extra assets to take more long positions in stocks.

Asset managers say the funds allow fund managers to make bets that more closely reflect their views on specific stocks, and that they allow fund managers to outperform a benchmark to a greater extent than a standard long-only fund.

Widely used in the US, where estimates of assets in 130/30 strategies range from $50bn to $70bn, the strategies are not used to the same extent by investors elsewhere.

UK-based investment consultants at Watson Wyatt, Mercer and Hewitt Associates have expressed caution over the funds, with few of their clients allocating any assets to 130/30 managers.

Last month, hedge fund information provider Infovest21 surveyed 57 institutional investors and found that more than two thirds were not using or planning to use the strategy within the next year. The firm estimates that assets held in 130/30 strategies worldwide total $75bn, suggesting that US investors are responsible for the majority of assets.

However, despite an apparent lack of interest on the part of institutional investors, several asset managers have followed their US counterparts by launching 130/30 funds in the UK, hoping that investors will take interest once the funds establish substantial records.

Aside from JP Morgan and Threadneedle, UBS has launched a US equities fund, F&C and Resolution Asset Management’s boutique Cartesian are focused on UK equities, while Invesco’s offering focuses on European stocks.

Other asset managers including Legg Mason and Edinburgh-based boutique SVM Asset Management are reportedly examining launching funds, and BlackRock, Société Générale Asset Management and Axa Rosenberg have brought funds to the UK.

Standard practice is for investors to wait for a fund’s one-year record—or, in some cases, a three-year record—before considering whether to invest in the vehicle. Investors are still cautious, but providers say they are laying the groundwork for a third way for investors to place their assets in the markets.