So far, so good.
While only a handful of managers have run 130/30 strategies for more than two years — and only one or two for more than five years — the early returns are strong.
Despite short track records and the lack of readily available information for evaluating strategy and performance, 130/30 managers said they are encountering strong institutional investor interest and are busy differentiating their approaches.
The main divide is between quantitative and fundamental managers. Quant managers dominate the area: There were only three fundamental managers among the 36 firms recently ranked by Pensions & Investments (P&I, April 16).
When it comes to alpha generation, some managers of short-extension strategies claim their edge is in adding alpha from the short bets they take. Sources said it’s exactly this ability — how much alpha managers add and how they got it — that will determine the long-term winners in this nascent market niche.
“Most fundamental managers spend their time finding names to buy rather than finding the stocks that are overvalued, but it’s in successfully shorting — underweighting — the latter stocks that we can add more alpha to the existing strategy,” said Scott Bondurant, executive director and head of Chicago-based UBS’ long/short equity investments.
Despite short track records, it seems clear that the addition of shorting to their existing investment process has resulted in better performance.
For example, the 130/30 offerings of three Boston-based quant managers outperformed their benchmarks for periods ended March 31. Acadian Asset Management’s Global Beta Strategy, with returns of 23.75% for the year and 4.78% for year-to-date, compared with 15.87% and 2.48%, respectively, for the Morgan Stanley Capital International All Country World–ND index. The Index Plus Edge Strategy managed by Street Global Advisors, Boston, returned 16.4% for the year and 1.64% for year-to-date, compared with 11.84% and 1.64%, respectively, for the Standard & Poor’s 500 index. The Numeric Amplified Core returned 14.89% since inception July 1, 2006, compared with 13.47% for the S&P 500 for the same period. Performance data is from eVestment Alliance, Marietta, Ga.
The 130/30 version of UBS Global Asset Management’s fundamental U.S. large-cap core equity strategy returned an annualized 18.94% (gross of fees) from inception on Sept. 30, 2005, to Dec. 31, 2006, compared with 15.75% for the long-only version and 14.1% for the benchmark Russell 1000 index. UBS managed $1.3 billion in its 130/30 strategy as of Dec. 31.
JPMorgan Asset Management, New York, had similar results for 130/30 versions of existing fundamental strategies. The firm’s U.S. large-cap core equity approach returned an annualized 14.68% from inception on June 30, 2004, through March 31, 2007, compared with 10.33% for the benchmark Standard & Poor’s 500 index. The value version of the approach returned an annualized 20.11% from inception on Nov. 30, 2005, through March 31, 2007, compared with 17.86% for the Russell 1000 Value index. JPMorgan managed $1.6 billion in short-extension strategies as of March 31.
Paul Quinsee, JPMorgan’s chief investment officer-core U.S. equity, said bottom-up managers have an edge on their quantitative colleagues. “Fundamental managers have unique, differentiating opinions on stocks that quant managers don’t,” he said. “A fundamental manager can dig really deeply into companies, which helps inform their opinions about them. If these insights are good, they can really add alpha.”
Naturally, quant managers have a different view.
Because quant firms rank the stocks in their universes nightly into buy, hold and sell categories, adding a short component is natural and leads to more efficient portfolio construction, said Bill DeRoche, senior portfolio manager of short-extension strategies at SSgA. SSgA is the 130/30 market leader, with $7.5 billion managed in four 130/30 strategies as of April 25, and company officials plan to launch U.K. and U.S. small-cap strategies soon, Mr. DeRoche said.
“It’s very easy for us to extend our quantitative models to short underweighted stocks. These short-extension strategies are identical to the products we’ve been offering for 14 years except that the long-only constraint has been removed,” said Mr. DeRoche. Ultimately, managing short-extension strategies depends on “how good your forecasts are, whether you’re a quant or fundamental manager,” Mr. DeRoche said.
Quant manager Tony Foley agreed. “It’s not really about quant vs. fundamental. What’s more important in managing 130/30 strategies is your mindset and how you look at performance,” said Mr. Foley, head of quantitative research and portfolio management at D.E. Shaw Investment Management, New York. Shaw managed $650 million in 130/30 strategies on March 31.
“Long-only managers tend to look for alpha in overweights in their portfolios ... because they get rewarded for the overweights that do well. Managers who are accustomed to shorting learn to develop the ability to look for alpha in underweighted stocks as well,” he said.
“Long-only managers are not accustomed to looking for companies in distress, on the verge of bankruptcy, as sources of alpha. The same goes for quant managers as for fundamental managers. The real question is whether they have evidence that they understand shorts and are managing them to generate alpha,” Mr. Foley said.
