Managers: 130/30 making comeback

Money managers who offer 130/30 strategies say the once high-flying investment strategy might be down but it's not out.

The hype of the years leading up to the financial crisis — when a flurry of products was launched on the promise of amplified alpha from an additional 30% of long exposure offset by a 30% short position — isn't likely to return, they concede.

Still, a number of managers predict 130/30 strategies could begin emerging this year from the wilderness they were consigned to after the global financial crisis left many sporting disappointing results for the first three to five years of their existence.

The mid-2007 performance meltdown by quantitative equity managers — which launched the bulk of strategies that have come to market since 2004 — deflated interest in 130/30, as did a broader, financial crisis-inspired flight from active management, said Daniel J. McCormack, senior management director, sales and relationship management, with The Boston Co. Asset Management LLC, Boston.

The current year, however, is bringing signs of a renewed appetite for risk, with more than 50% of The Boston Co.'s new business year-to-date in active U.S. large-cap equity strategies, Mr. McCormack noted. Those inflows have yet to extend to the $360 million U.S. large-cap core 130/30 equity strategy the firm launched in May 2007, “but I do expect it by year-end,” he said.

It's still early, but as the clouds that have been hanging over quant firms in recent years disperse, and the need for returns boosts investors' tolerance for risk. “I think that you'll begin to see more interest in 130/30” again, agreed Churchill Franklin, executive vice president and COO with Boston-based Acadian Asset Management LLC.

For now, it's the minority of fundamental equity managers in the quant-dominated 130/30 universe reporting the strongest evidence of interest in the strategy.

Lee Spelman, a New York-based managing director and head of U.S. equity client portfolio managers with J.P. Morgan Asset Management, said her company has a “queue of several billion dollars” of clients waiting to get into J.P. Morgan's $17.3 billion large-cap 130/30 strategy, which closed to new investors two years ago because of capacity constraints.

With more than two decades of experience shorting stocks for long-short strategies, and the kind of extensive research effort needed to rank the market's most expensive stocks as well as those offering the greatest value, J.P. Morgan's 130/30 team has topped its S&P 500 benchmark by an annualized 4.72 percentage points since the strategy's launch in July 2004, she said.

J.P. Morgan remains “firmly committed to this form of very efficient portfolio construction,” said Ms. Spelman, who noted that one of the company's newer offerings — the Research 130/30 strategy launched in August 2007 — just won a $750 million mandate in May. She declined to identify the client.

Carol Geremia, Boston-based president of MFS Investment Management's institutional asset management subsidiary, MFS Institutional Advisors, said the performance of the MFS Blended Research 130/30 All Country Global Equity strategy has likewise been strong, besting its MSCI All Country World index benchmark by an annualized 3.65 percentage points since the strategy's launch in July 2008.

Amid a tough market environment, the strategy hasn't attracted a “ton of interest,” conceded Ms. Geremia; despite its strong performance, the strategy had only $5.5 million of MFS seed money as recently as April.

However, as plan executives continue to seek alpha and diversify “how they're getting (that) alpha,” 130/30 could well enjoy a pickup of interest, she predicted. By way of example, at the end of May, the Blended Research 130/30 strategy garnered its first big mandate — US$255 million from a Canadian institutional investor, she said. She declined to identify the investor.

By contrast, quant managers offering 130/30 strategies say they have yet to spy signs of the pickup in interest their fundamental or blended competitors are enjoying. They say a number of investment consultants remain reluctant to embrace the concept.

Eric Petroff, director of research with Seattle-based Wurts & Associates, counts his firm among the unbelievers, who reject the “investment thesis” that 130/30 offers investors any particular advantages. For clients open to removing constraints on their managers, Wurts recommends long/short strategies, he said.

Erik Knutzen, chief investment officer of Cambridge, Mass.-based investment consultant NEPC LLC, said his team likewise remains convinced that 130/30 is a means for institutional investors “to back into hedge fund exposures,” and NEPC urges investors moving in that direction “to consider equity-oriented hedge funds.”

Harindra De Silva, the president of Los Angeles-based quantitative equity firm Analytic Investors LLC., counters that such recommendations miss the point: sophisticated investors allocating money to the strategy positively want beta exposure as well as alpha, with 130/30 offering a more efficient means of combining the two than, for instance, portable alpha.

If many investment consultants remain skeptical, others agree with quant managers that 130/30 could be poised for a comeback.

Artemiza Woodgate, a senior research analyst with Seattle-based Russell Investments, predicted 130/30 won't prove to be a “fad.” Quantitative managers this year are emerging from a period of rough performance, and that upswing might well set the stage for return-hungry investors to reconsider 130/30 strategies, she said.

Eileen Neill, a managing director with Santa Monica, Calif.-based Wilshire Associates, said her firm likewise remains “relatively positive” about 130/30, which can offer advantages — including transparency and the ability to add risk-controlled alpha in efficient market segments such as large-cap equities — that investors are seeking. She said 130/30 is among the strategies Wilshire is recommending to clients now, and sophisticated investors have been open to the idea.

One executive of a multibillion-dollar retirement plan, who declined to be named, said he sees 130/30 as a superior investment vehicle to a hedge fund, which by comparison is “expensive, restrictive and subject to dilution and liquidity risk. ... There is nothing proprietary about (a hedge fund's) investments, so if you find a better vehicle (such as 130/30) and competitive team then go with it,” he said.

Kevin P. Kearns, a vice president, portfolio manager and senior derivatives strategist with Loomis, Sayles & Co. in Boston, noted that earlier this year one of his firm's major institutional clients, Hartford, Conn.-based United Technologies Corp., expanded a more than $700 million long-only credit mandate with Loomis to overlay a long-short credit component, in an effort to generate alpha through credit selection “without taking directional risk.”

Especially in the context of liability-driven investment programs, that kind of arrangement could well be seen more in the future as investors seek more returns with limited downside risk, Mr. Kearns said.

Charles Van Vleet, director, pensions investments, with UTC, confirmed the details of the Loomis mandate. He declined further comment.

Other gatekeepers give 130/30 a qualified blessing. 130/30 isn't as big an idea in the marketplace as its backers initially claimed, “but there's room” for the strategy to be effective in some cases and for some market segments, said Timothy R. Barron, president and CEO of Darien, Conn.-based investment consultant Rogerscasey Inc. It will remain “an attractive way to leverage up certain strategies,” he said.

Michael Even, the president and CEO of Boston-based quantitative equity shop Numeric Investors LLC, said that logic prompted his firm, in the face of the market's considerable headwinds, to launch an emerging markets 130/30 strategy in April 2010.

The market segment is tailor-made for 130/30, argued Mr. Even, noting that investors are keen to take on emerging markets beta exposure. Moreover, the symmetry between the positive and negative returns delivered by the top and bottom deciles of that market, and the more than three-quarters of the companies in the emerging markets index sporting an index weight of 20 basis points or less — too small to boost performance appreciably simply by opting not to own them — likewise recommend that investment structure, he said.

Despite outperforming its MSCI Emerging Markets benchmark by 7.5 percentage points over its 14-month existence, it has remained difficult to interest gatekeepers and institutional investors in the strategy, concedes Mr. Even.

Still, executives at quant firms — including Acadian, Aronson Johnson Ortiz LP and First Quadrant LP — point to the fact that clients who invested in their 130/30 strategies ahead of the financial crisis have largely stuck with them as evidence that the concept has staying power.

Even if new investors haven't been rushing to put 130/30 in their portfolios recently, “people who are in it still have real conviction in the product,” noted Max Darnell, Pasadena, Calif.-based First Quadrant's chief investment officer.