130/30 managers were pummeled by turbulent markets in July and early August, but most now are pulling themselves off the mat.
Enhanced index managers also took a bruising in July, but appear to be rebounding as well.
Underperformance might hurt the standing with institutional clients of these usually reliable strategies.
“The question is whether clients will be less willing to put up with underperformance, when fear of it was the whole reason they were in enhanced indexing in the first place,” said Jeff Nipp, director of investment manager research in Watson Wyatt Worldwide’s Atlanta office.
Active extension and enhanced indexed managers were hurt when large, quantitatively driven hedge fund managers were forced to deleverage their portfolios after the subprime mortgage problems hit home. Quant-driven hedge funds were forced to sell off a lot of long positions, decreasing their value, and buying stock to cover short positions, increasing the value of these dog stocks.
Several managers and a consultant said the deleveraging hit its peak on Aug. 9, and that performance for active extension strategies has improved since then.
According to data from the PSN investment manager database of Informa Investment Solutions Inc., White Plains, N.Y., some active extension managers taking the biggest pounding in July included:
cIndependence Investments LLC, Boston, whose 130/30 strategy underperformed its benchmark, the Russell 1000 index, by 237 basis points in July;
cDeutsche Asset Management, New York, whose large-cap growth 130/30 strategy underperformed its benchmark, the Russell 1000 Growth index, by 217 basis points;
cFuller & Thaler Asset Management Inc., San Mateo, Calif., whose 120/20 strategy underperformed the benchmark Russell 1000 index, by 149 basis points;
cLos Angeles Capital Management & Equity Research Inc., Los Angeles, whose 120/20 strategy underperformed its benchmark, the S&P 500, by 128 basis points.
John Forelli, a senior vice president and portfolio manager for Independence Investments, attributed underperformance to the unwinding of hedge funds. The strategy was showing signs of recovery in August, he said.
Deutsche spokeswoman Mayura Hooper said that Deutsche’s growth 130/30 was just 22 basis points behind the benchmark for the month of August. The strategies are too new “to make any generalization about the performance of 130/30 strategies in this type of a market,” Ms. Hooper wrote in an e-mail responding to questions. “The fact that we underperformed the benchmark in July and then have hugged the benchmark so far in August is indicative of the problems in drawing conclusions about a trend.”
Not surprised
Stephen Bard, chief operating officer for Fuller & Thaler, said the strategy underperformed in July because the value-related factors in the model did not work well. He said he was not surprised by July’s performance, noting that in 25 years of back testing, they found the strategy usually underperforms right before a recession. He also noted that as of Aug. 30, performance was 23 points ahead of the benchmark for that month.
Hal Reynolds, chief investment officer for Los Angeles Capital Management, attributed the underperformance to a value bias in the portfolio and also being slightly underweight to larger companies in the S&P 500. “Those companies outperformed in July,” he said.
“Generally they (short-extension strategies) were beaten up through (Aug.) 10, but they’ve recovered since then,” said Jay Love, a principal and senior consultant in the Atlanta office of Mercer Investment Consulting Inc.
Ten of 17 managers of 130/30 or other so-called active extension strategies underperformed their respective benchmarks during the month of July, according to PSN data.
These newly popular strategies short a percentage of the portfolio, but balance that with extra-long positions so the overall portfolio has full market exposure. A 130/30 strategy goes 130% long and 30% short, for instance.
Only 33 of 104 enhanced index strategies outperformed their respective benchmarks in July, according to the data.
August performance was not available, but anecdotally, investment consultants who have talked with 130/30 managers said many of the strategies continued to underperform until about mid-August; there have been signs of improvement since then.
While noting the recovery of most 130/30 strategies, Mr. Love wasn’t surprised that active extension strategies underperformed in July’s market. “They have more active risk than long-only managers, so they should have produced more negative alpha,” he said.
While many types of strategies suffered weak performance in the volatile markets of July and August, 130/30s were scrutinized closely.
“Very few of these managers have track records of more than a couple of years. This is a real test for them,” Watson Wyatt’s Mr. Nipp said.
Boston-based State Street Global Advisors, one of the largest managers of active extension strategies, is not in the PSN database. Ric Thomas, managing director and head of SSgA’s North American enhanced equity group, which oversees 130/30 strategies, said performance was down at the beginning of August then rebounded. He said he wouldn’t cite specific performance data because it had not yet been viewed by clients.
Performance down
Performance was down for SSgA and other quantitative managers who used value as one of their stock ranking factors, Mr. Thomas said. “Value models haven’t worked very well over the past few months in the U.S. Our other models more associated with momentum have worked well,” Mr. Thomas said. “But value models have been so negative it has subsumed a lot of the other models in July.” Some of SSgA’s 130/30 strategies were outperforming their benchmarks, Mr. Thomas noted.
A new 130/30 strategy for Glenmede Investment Management LP, Philadelphia, was also down in July. (Glenmede’s performance is not in the PSN database.) “It got hit in early August too, but has rebounded and showed a positive rate of return relative to the index,” said Gordon B. Fowler, managing partner and chief investment officer of the firm. He declined to share specific numbers.
“This period has emphasized one of the big benefits of 130/30s. They’re not overleveraged,” Mr. Fowler said. He explained that the largest long/short or market-neutral hedge funds did not have time to releverage their portfolios and take advantage of the “mid-August bounceback.”
July and August also put some distance between active extension strategies run by quantitative and fundamental managers, said Mercer’s Mr. Love. The fundamental managers “didn’t have the same shorts that the quants did,” Mr. Love noted. “The quants were all in similar longs and shorts.”
Fundamental active extension strategies will not always outperform their quantitative brethren, said Scott Bondurant, global head of equity long/short investing at UBS Asset Management, Chicago, which has $2.3 billion in fundamental 130/30 strategies. However, “what’s clear is that fundamental managers will produce diversified returns because they’re trying to get alpha in a different way,” he said.
Enhanced index strategies, which are also run predominantly by quantitative managers, underperformed their benchmarks in July as well. Of the 71 enhanced index strategies in the PSN database that underperformed benchmarks in July, 32 did so by more than 50 basis points.
According to Pensions & Investments’ data there is a total of $449 billion in institutional, tax exempt assets under management for enhanced index strategies as of Dec. 31.
SSgA’s U.S. equity enhanced index strategy, with $7 billion, was down 10 basis points for July. Much like 130/30 strategies, Mr. Thomas said the portfolio did rebound in August.
But all strategies go through periods of underperformance, Mr. Thomas said. “We’re expected to add value. And over many years we have.”
One of INVESCO’s enhanced equity strategies benchmarked to the Russell 1000 underperformed by 154 basis points in July, while another enhanced strategy benchmarked to the S&P 500 underperformed by 16 basis points in July. “For the month of August we’ve come back from what we lost,” said Diane Garnick, a New York-based investment strategist for INVESCO PLC, Atlanta.
