130/30 is making a comeback, managers contend

But the hype of the years leading up to the financial crisis — when a flurry of products were 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 that 130/30 strategies could begin emerging this year from the wilderness to which they were consigned 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 of sales and relationship management with The Boston Co. Asset Management LLC. 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, he said. Those inflows have yet to extend to the $360 million U.S. large-cap-core 130/30 equity strategy that the firm launched in May 2007, “but I do expect it by year-end,” Mr. McCormack said. It is still early, but the clouds that have been hanging over quant firms in recent years are dispersing, and the need for returns is boosting investors' tolerance for risk. “I think that you'll begin to see more interest in 130/30” again, said Churchill Franklin, executive vice president and chief operating officer at Acadian Asset Management LLC. For now, it is the minority of fundamental-equity managers in the quant-dominated 130/30 universe reporting the strongest evidence of interest in the strategy. J.P. Morgan Asset Management has a “queue of several billion dollars” of clients waiting to get into the firm's $17.3 billion large-cap 130/30 strategy, which closed to new investors two years ago because of capacity constraints, said Lee Spelman, the firm's managing director and head of U.S. equity client portfolio managers. 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 — won a $750 million mandate last month. She declined to identify the client.

STRONG PERFORMANCE

The performance of the MFS Blended Research 130/30 All Country Global Equity strategy likewise has 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, said Carol Geremia, president of MFS Investment Management's institutional asset management subsidiary, MFS Institutional Advisors Inc. Amid a tough market environment, the strategy hasn't attracted a “ton of interest,” she said. 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, Ms. Geremia said. By way of example, at the end of last month, the Blended Research 130/30 strategy garnered its first big mandate: $255 million from a Canadian institutional investor, she said. Ms. Geremia declined to identify the investor. By contrast, quant managers offering 130/30 strategies said that they have yet to spy signs of the pickup in interest that their fundamental or blended competitors are enjoying. They said that a number of investment consultants remain reluctant to embrace the concept. Eric Petroff, director of research with 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 consultant NEPC LLC, said that his team likewise remains convinced that 130/30 is a means for institutional investors “to back into hedge fund exposures,” and the firm urges investors moving in that direction “to consider equity-oriented hedge funds.” But Harindra De Silva, president of quant-equity firm Analytic Investors LLC, said 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, he said.

NOT A 'FAD'

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 Russell Investments, predicted that 130/30 won't prove to be a “fad.” Quant 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. Wilshire Associates Inc. 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, said Eileen Neill, a managing director. She said that 130/30 is among the strategies that Wilshire is recommending to clients, and sophisticated investors have been open to the idea. One executive of a multibillion-dollar retirement plan, who asked not to be identified, said that 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.” Kevin P. Kearns, a vice president, portfolio manager and senior derivatives strategist with Loomis Sayles & Co. LP, noted that this year, one of his firm's major institutional clients, United Technologies Corp., ex-panded 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 be seen more as investors seek more returns with limited downside risk, he said. Charles Van Vleet, director of pension investments with United Technologies, confirmed the details of the Loomis mandate. He declined to comment further. Other gatekeepers give 130/30 a qualified blessing. The strategy 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 chief executive of investment consultant Rogerscasey Inc.

LOGICAL CHOICE

Michael Even, the president and chief executive of quant-equity firm Numeric Investors LLC, said that logic prompted his firm, in the face of the market's considerable head winds, to launch an emerging-markets 130/30 strategy in April 2010. The market segment is tailor made for 130/30, he said, 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, recommends the investment structure, Mr. Even said. Also, that fact that more than three-quarters of the companies in the emerging-markets index sport an index weight of 20 basis points or less — too small to boost performance appreciably simply by opting not to own them — likewise make it attractive. Despite outperforming its MSCI Emerging Markets benchmark by 7.5 percentage points over its 14-month existence, the strategy has largely failed to gain the interest of gatekeepers and institutional investors, he said. Still, executives at quant firms — including Acadian, Aronson Johnson Ortiz LP and First Quadrant LP — pointed to the fact that clients who invested in their 130/30 strategies ahead of the financial crisis largely have 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,” said Max Darnell, First Quadrant's chief investment officer. Douglas Appell is a reporter at sister publication Pensions & Investments.