In its first ever roundtable on the topic, Global Pensions gathered industry experts in London to discuss the long and short of 130/30 funds
Alex Beveridge: Pension funds have a history of being late-comers to new asset classes and investment styles. Why then have they been amongst the first movers in the 130/30 phenomenon?
Andy Barber: I suspect it's because it's something that affects an asset class with which trustee groups are very familiar. It's about equities, where they're familiar with active management techniques. Some of the people putting forward such strategies have been good proponents about the theoretical reasons as to why 130/30's a good idea, so it's been easier for trustees to look at 130/30, understand what it's all about and to make the decision.
John Delaney: In many cases, certainly in the US where the early adopters emerged, we saw pension funds going to their managers, who had provided good returns for them in long only, and they were extending that - no pun intended. Therefore as long as they were confident of the alpha signals and, certainly the quants, could demonstrate through back-testing that they could bring something new to the party, then it was a relatively easy step to move into extension strategies.
Alex Beveridge: Gerry, do you think it was that level of comfort that led to the early adoption?
Gerry Paul: That's part of it, but you could also argue they're not at the forefront. What we're doing in 130/30 is taking tools like shorting that alternative managers have been using for a long time, and applying them in a way that is more conservative. So you're taking a modest degree of incremental exposure to try to amplify the signals that you think a skilled manager already has, and it's being done, not in a new asset class, but to try to amplify returns in the asset class which is most popular, that being long only equities.
Susan Kenneally: The early adopters in the US were primarily the public funds which had not had a lot of exposure to the alternative or hedge fund asset class, and this was a way to reach in that direction.
Ted Roman: We believe there are three or four fundamental reasons why this approach has become so popular. In every trade you have a buyer and a seller. In this case, the buyers are pension plans and individuals, in many cases baby-boomers. So you start with a product that has a natural demand, you add to that the theoretical substance, the transparency and the understandability of equities, and you have a product which solves a problem, namely under-funding, and it does so in a way that can be structured, at least in the US, namely as a separately-managed account, or a mutual fund, with liquidity, transparency and a fee structure that makes the buyer comfortable.
Alex Beveridge: Ramon, what's the Dutch perspective?
Ramon Tol: Many pension funds tend to be somewhat sceptical towards shorting as it is often associated with hedge fund strategies which are frequently considered to be too expensive or too risky. A lot of pension funds probably consider this a stepping stone towards the extreme, which is an active market neutral strategy. Many of them also have restrictions on shorts and market neutral strategies and perhaps hedge funds in general, so whereas hedge funds and market neutral strategies may be a bridge too far for a lot of institutional investors, this could be a middle ground solution.
Andy Barber: Do you think ultimately that if people become comfortable, pension funds might go to market neutral and then re-equitise if they want?
Ramon Tol: That might very well be the case and that has already taken place for some of the larger, more sophisticated pension funds.
Gerry Paul: Well, if not market neutral, something other than 130/30, because there's nothing magic about the number.
Andy Barber: No. 130/30 seems to have become the industry term, whereas it isn't necessarily going to be that and, indeed, for different products the actual long/short exposure may well vary over time.
John Delaney: The point for flexibility is an interesting one, to give managers another release of constraint in terms of moving the exposures around 130/30, 140/40, 110/10, depending on market conditions. As you mentioned, volatility's spiked up in markets over recent times, and bringing down those levels would probably be more appropriate now than a year ago.
Ted Roman: Our view is slightly different, that is, that 130/30 represents a variant of a beta one product, with a beta in the range of 0.85 to 1.15. It is clearly not zero as in a market neutral fund or negative as in a dedicated short fund. We believe 130/30 and the hedge fund world fall into two distinct buckets; a bucket that's relative return driven and a bucket that's absolute return driven. The cross-over position is portable alpha, where you have a total return swap or futures and you combine that with a market neutral product.
Ramon Tol: I must admit though when I look at the Dutch pension funds, some of them are pretty advanced, they have invested in market neutral funds and hedge funds, including overlay strategy, for quite some time. But there are still many conservative pension funds out there, and for them this might be the first step.
John Delaney: Yes, it's a small step out of the comfort zone, where, as Ted says, you're still broadly beta one, you're still 100% invested and therefore you're still in your comfort zone of an equity bucket investment.
Susan Kenneally: I think this will be part of plan schemes for quite some time, because the cost of market neutral strategies is large, choosing those managers is difficult and winning in market neutral is difficult. So moving that to a larger portion of a portfolio takes on a lot more risk than just the investment risk.
Alex Beveridge: 130/30 funds have burst onto the scene, particularly over the last six months to a year. Is this sudden interest because some of the public funds in the US have embraced them?
Ted Roman: Most concepts have to be sold to trustees and require a theoretical underpinning. The participants in the marketplace can be categorised into four broad categories; the investors - e.g. beneficial owners, the investment managers, the consultants, and finally the sell-side service providers. We think 130/30 potentially has advantages for all of them - for the beneficial owners increased alpha, for hedge funds [a] different pool of investors, traditional long-only managers learn new skills - short selling and working with prime brokers, consultants a broader role, and service providers expanded opportunities. When you have a product that potentially benefits many participants, it is perhaps just a matter of time and exposure, so I'm not sure if 'sudden' is necessarily the right description.
Gerry Paul: But the timing was certainly right. There is a big gap, at least in the US, between what plan assets can earn with traditional mixes and what the plans need to earn. So there's a need for managers to add more return relative to a benchmark. Until recently, spreads were narrow in most markets, so the ability of active managers to add return was weaker than normal. This was amplified by some capitalisation distortions; the biggest companies in a benchmark looked to be more attractive than the smaller companies. And so inside a benchmark sensitive portfolio, the active share for a traditional manager compared is a fraction of what it used to be six or seven years ago. One way to amplify your active share is by relaxing the long only constraint and getting more of your point of view into the portfolio.
Alex Beveridge: John, they certainly seem to be taking off over here as well and in Europe.
John Delaney: Yes, I agree with Ted's point, I don't think it's been sudden, momentum has picked up of late and that's partly because there's been more written about 130/30 and people are talking about it. Gerry's point is spot on in terms of the timing being good as well. The allocations have been large because of the nature of the product fitting into the equity bucket, and that has certainly increased appetite from a supply perspective.
Ted Roman: The other point I'd like to raise in terms of 'sudden' is history is a great teacher. If you begin in 1981, when the Fed determined that inflation would be wrung out of the US economy, there were several major corrections between 1981 and the winter of 2000. But every time, those corrections represented buying opportunities. It wasn't until the winter of 2000 to the fall of 2002 that markets went down for a long period of time and went down dramatically. Shorting became a well-known, widely accepted process. It wasn't until 2000 that there was a great interest in doing something other than "buying on the dip."
Gerry Paul: Behind your comment is the idea that to be successful with short selling you have to have stocks go down, and that's not really true in a 130/30 product. To us the appropriate comparison is; is a 130/30 or extension product better at delivering alpha relative to risk than a long-only product? As long as you're earning a spread between your longs and your shorts, you're better off in a 130/30 product - in rising markets or in falling markets - than you would be in a long-only product.
Ted Roman: I agree. My comment was more directed towards the acceptance of shorting.
Alex Beveridge: Andy, do you have a view on what's caused the pick-up in 130/30 strategies?
Andy Barber: I suspect that the key thing that might be tipping it in the UK is the desire to make the assets sweat a bit more.
Alex Beveridge: Everybody's suddenly now able to short the market and understands it, but is there enough capacity in the markets for all the necessary stock lending and shorting?
Ted Roman: For the larger capitalisation benchmarks, we believe so. As you move down the capitalisation spectrum it's not clear. Just think of the number of small cap long-only managers who have closed their products. In these cases, it has nothing to do with capacity on the short side, it has to do with alpha on the long side. So there are two questions. Is there enough capacity on the short side? But also, is there enough alpha on the long side to support these products?
John Delaney: Our desk hasn't seen any impact from 130/30 strategies in terms of constraints of capacity. People are looking to use portfolios more effectively and efficiently to create return and more people lending them out is going to help supply. Ted's right in terms of the smaller indices, you'd be mindful of that. At the moment most of the product has been in the larger indices. You can get constraints in these markets, but they're not necessarily going to be driven by 130/30, they could be driven by a general thematic preference for moving away from small caps into large caps, which could tighten supply.
John Delaney: The other dynamic here is that you need to think hard about how you trade the short side. It's a more technical discipline than long-only. We encourage managers to have a dialogue with the stock loan desk so that they're not the last in when the trade has already been put on by everybody else and they can be aware of the technical factors in the market.
Gerry Paul: In general, the supply of stock to lend has responded to demand. But there may be some problem areas. Keep in mind that a 130/30 service is benchmark-sensitive whereas most hedge funds are not. As such, shorts in a benchmark sensitive portfolio are going to be pushed into the smaller names in the benchmark, because a negative point of view on larger names can be effected by simply not owning them. There is a strong statistical relationship between market cap and absence of availability and high borrowing costs, in part because hedge funds have been systematically over-exposed to small and mid cap stocks in both long and short portfolios. But high borrowing costs are just another investment constraint, in a way. And the way around this constraint is to use a large universe because it makes it easier to find substitutes. When you've got a very large universe of stocks to choose from, you can move on to the next one if your first idea turns out to be too expensive.
Ramon Tol: In general, there is still ample capacity in the market for these types of products. From a manager selection point of view, the capacity limit is going to be more critical than in the long-only world, because of the borrowing costs. Capacity limits for these types of products are going to be significantly lower; an increase in short positions because of growing assets under management will easily lead to higher borrowing costs, not to mention that some stocks are hard to borrow and incur higher borrowing costs. In large caps that shouldn't be an imminent problem, but we shouldn't forget that the stocks which are being shorted are very often the smaller capitalisation stocks where borrowing costs are higher than for large caps. Gerry Paul: But we should keep in mind that the performance drag from high capacity utilisation in a short portfolio is not exactly the same as the costs on the long side, for two reasons. First, in aggregate, the short capital in a 130/30 fund is one-fifth to one-sixth of the total capital, so if you're equally effective at adding premium in long and short, an erosion of premium due to high capacity utilisation on the short end has a smaller effect on total returns than it would on the long end. Second, shorts are playing a variety of roles in the portfolio from pure risk control to pure alpha, and finding the way to manage along that spectrum in a large universe is relatively easy. So you're right in that it's important to have this conversation about capacity with the manager, but calculating the impact is more complicated than it would be in a long-only portfolio.
Andy Barber: The other thing you have to take into account is the long-only assets the manager's running, and not only the long-only assets in the domestic market in which you might have a long/short, but an international product.
Gerry Paul: Yes, a manager may run out of long-only capacity before they run out of long/short capacity if they're new to this business.
Susan Kenneally: You also have to ask your manager how they pick their shorts. In other words, is there expected return, after borrowing costs or before? That needs to be integrated as part of the short decision-making.
Alex Beveridge: What process does an asset manager have to go through when they transform themselves from a long-only to effectively a long/short product provider?
Susan Kenneally: Clearly experience on the short side is very important, because there are different characteristics in that part of the portfolio. Secondly, executing operationally, technologically, there are different hurdles as well; in the US working within a prime brokerage relationship, in Europe working with swaps through a UCITS structure if you can't do separately managed accounts. It is not just about being able to choose the appropriate short equity to put in the portfolio, it's about executing, costing it, pricing it, delivering it within the structure.
Ted Roman: We think the decision to go into either the 130/30 product or the hedge fund product is first a business issue. Many long-only managers have concentrated portfolios and close relationships with the companies whose stock they own. Going into the shorting business may have important implications for those organisations. Second is the broad issue of managing the money, and third is the operational skills. From an operational perspective, there are important considerations, starting with the legal and compliance issues of side-by-side trading. Then there are adjustments to the order management and the execution management systems, the pricing systems and the portfolio construction and risk management systems. For hedge funds the issues are different, because hedge funds already work with prime brokers and already have the infrastructure for short selling. For them it's an issue of pricing and allocation of alpha.
Ramon Tol: One of the key issues is risk management. You need a different risk management system. Whereas in the long-only world the risks are limited, your overweights decrease as a result of an underperforming stock, on the short side potential losses are unlimited when their prices increase.
Alex Beveridge: Andy, if somebody you've been dealing with for years as a long-only manager comes to you and says, 'We've got a 130/30 fund,' what are you looking for?
Andy Barber: You start off with a high degree of scepticism. I agree with the comments about the necessity to have the infrastructure in place, but the key to running it successfully is the ability to generate alpha on the short side. It does require a different way of thinking about things. I suspect at the moment there are a lot of managers out there running paper long/short, or paper 130/30. I expect in due course to see those that have built up a reasonable track record come to market, and you'll be sceptical about survivor bias going on there, and time will tell on that.
Gerry Paul: From a manager point of view, the biggest hurdle in transformation is dealing with the recognition that being short is not the opposite of being long, but there's this asymmetry in return and asymmetry in risk. Then you've got to have a source for short ideas. Having a quantitative tool that can identify underperformers is the first step toward accomplishing this which is probably why you've seen 85% or 90% of the market use quant managers so far. On the other hand, identifying shorts theoretically and capturing their performance in a portfolio on a day-to-day basis are two different things. For one thing, you have to wrestle with differences in volatility in a short portfolio versus a long portfolio and understand how to pair those two things together.
Alex Beveridge: Is there a danger that in a few years' time a number of managers simply won't have the necessary skills or infrastructure to properly apply these products, and investors will get burnt?
Andy Barber: It's inevitable and it's not just a 130/30 scenario. People are upping risk levels in long-only portfolios too. My suspicion is that in three or four years' time there are going to be some pension funds who are very happy with what's gone on and some who are very disappointed.
Gerry Paul: Whenever you relax a constraint for a manager, you're shifting the source of the return away from the beta component. So finding a manager that has a lot of skill becomes more important as you start to relax these constraints, which is why, for example, when you look at the dispersion in hedge fund returns, they're multiples of the dispersion of returns in traditional long-only products, because the managers have a lot of room to add value and a lot of room to detract value. There will be people who are at the bottom of that distribution and people who are at the top. The key is trying to figure out who's going to be where in advance.
Alex Beveridge: Ted, you've been watching this for a while, have there been people who've tried and failed and are there lessons to be learned for pension funds?
Ted Roman: The lessons to be learned are twofold. In the early days, quantitative managers had a distinct advantage in that they could back-test and provide simulated results. The problem is that the back-test assumes that the regime going forward will be similar to the regime in the past on which the back-test is based. In the 130/30 business, the stock borrow rebate is an important component of the back-test, and few prime brokers have stock borrow rebate information on hard to borrow securities going back for a meaningful length of time. This lack of data adds to the challenges of providing accurate back-tested results. Importantly, for the future of the business, many fundamental managers and managers who combine fundamental and quantitative techniques have now adjusted their infrastructure, established a relationship with a prime broker and set up test accounts with reasonable levels of funding, so that in the future they can run the money in a way that would reflect larger allocations. Many of these test accounts are now reaching the one-year mark. So, with the need for increased returns we're going to see a substantial number of either fundamental or fundamental and quantitative products come to market with an actual track record.
Andy Barber: But again, I don't think it does away with the fact that you might have 100 of those products being run on a realistic basis, but the ones you're going to see are the ones that have survived.
Ted Roman: Yes, absolutely.
John Delaney: I would think that's a good thing, though. That people that have made it work on a paper basis bring it to market.
Gerry Paul: Well, no, the point is that it doesn't tell you whether they were lucky or smart. Maybe it's only the lucky ones that come out. For sure, only the products with good records will be launched.
Ramon Tol: I must admit there are databases which take into account survivorship bias. The problem is to keep the database updated. To reduce the survivorship bias, we want these track records to remain included in the database.
Alex Beveridge: We said before that one of the reasons pension funds might have been first-movers was because they were comfortable with their managers and were just giving them a little bit more room to make the assets sweat, so to speak. But a lot of pension funds I speak to won't enter an asset class or new strategy until they've seen it run for quite a while, so Andy, have we got enough data on 130/30?
Andy Barber: No, not really. They've been running in Australia for longest, and the performance has been mixed. Some of the performance you'd expect, long-only's done okay, the 130/30 has done better, and tracking error's higher, the information ratio is greater. But there are others that haven't performed to those patterns. Is that because they've been wrong on the cost of shorting? Is it because it's been an odd period? I don't think there's enough evidence yet to conclude anything.
Gerry Paul: We should expect these outcomes to look like any universe of managers, where there are some that are successful and some that are not, which underscores your earlier point that picking the right manager is even more important here.
John Delaney: Yes, that's right, there's going to be a distribution of returns and it will depend on their process and the signals they generate. But in terms of an end investor making an allocation, there's going to be some signals that work, that will give them confidence to put money with a manager which are, for instance: have they done well on the long-only side? Have they got a compelling back-test to look at? Do they know them well? Are the risk management systems deemed to be adequate? That's why we've seen people going into the strategy on the basis that there isn't a long track record in many cases, because these have been transition trades for some people with known managers.
Ramon Tol: You need at least 36 months of manager data before an information ratio and tracking error becomes statistical significant. Only a handful of managers have a track record of three years or longer, as far as I am aware. But if you group them all together and see how many do better than, for instance, their long-only counterpart products, or how many at least achieve a positive information ratio, then you might be able to say a little bit more. We did some research last year where we had a large group of 130/30 managers and compared their 130/30 performance track record to their long-only counterpart products. The results were mixed. It'll be interesting to see how they performed in 2007, especially during the quant turmoil in July and August. The research will be updated in 2008.
Susan Kenneally: In the US, where there is the largest dollar amount invested, a lot of these are exploratory forays in that they're not shifting huge portions of their long-only assets to 130/30, they're using a smaller portion of the asset to test how it works.
Ted Roman: Another point Susan has raised is that in the US, as opposed to Europe, the vehicle structuring is potentially simpler. To date, most of the mandates in the US have been structured as separately-managed accounts. As a result, you have transparency and liquidity and a similar structure to the ones currently used by long-only managers. Pension plans understand this structure both from a portfolio management and an operational perspective. The market structure in the US makes it easier to unwind your decision.
Alex Beveridge: Right, so it's easier to make those exploratative forays because you can get out of it should you realise you've made a mistake. If I could ask the managers now, how have you found the consultants have reacted to 130/30?
Gerry Paul: On the theoretical case for 130/30 there's been a range of reactions, from enthusiastic embracing to tremendous scepticism. But there is greater uniformity in the tremendous scepticism on the part of most consultants, and rightly so, about whether or not a manager's skill in the long arena translates into long-short. We have found that the bulk of our conversations with consultants have centred on that ability.
Ted Roman: The other issue is form. The initial form was quantitative managers. I then expanded to quantitative and fundamental managers acting independently. There has been at least one public product in the United States which is a 130/30 fund of funds. So the question is whether that form addresses some of these issues of diversification, manager selection, risk control and capacity. It will be interesting to see whether the fund of funds business, from a 130/30 perspective, has the same acceptance as fund of funds in the hedge fund business.
Susan Kenneally: What about pricing? The cost of hedge funds for some of these plans can be quite high and so 130/30 is a baby step, but if you put together a fund of funds you've got two layers of cost.
Alex Beveridge: People have suggested to me that some hedge funds were slightly nervous about the advent of 130/30, because they felt pension funds might be able to get more meaningful investments with them at a lower fee.
Ramon Tol: Some have reacted to that. A lot of the hedge funds themselves have now launched 130/30 products.
Alex Beveridge: Andy, are you comfortable now with the manager offerings?
Andy Barber: There are some products with which we are comfortable and some with which we're not. We're just viewing them as high alpha - like long-only, you're getting the beta of the market and here's a way of getting extra return. In theory, if you believe a manager has got skill on both the long and the short side, you'd probably prefer to have his 130/30 to the traditional long-only, because you ought to get a higher information ratio out of it. But for the consultancy profession in general, it's been a learning experience, trying to judge whether people do have the skills on the short side.
Susan Kenneally: It's a different type of record you're looking at from them, which is not necessarily absolute return overall. The second question is, do they have adequate risk controls, because you're probably dealing with a larger pool of money that has a beta component, and the risk adjustment is somewhat different.
Andy Barber: And they have to have a broader coverage of the market. In the long-short space, if you decide you've got no idea about pharmaceuticals, you can just ignore them.
Ramon Tol: That's a problem with a lot of the long-only funds, and perhaps also some of the non quantitative hedge funds moving into the 130/30 space; they often have highly concentrated portfolios, focusing most of their research efforts on the high conviction bets and at the same time paying less attention to the underweights or stocks not held in a portfolio. When it comes to shorting, you need to have a much more broad ranking of stocks, including a view on the stocks which you believe are going to underperform. Research shows that long-only managers generally do less well and often "miss outperformance" in the underweighted stocks or benchmark stocks not held in the portfolio.
Ted Roman: Our experience has been somewhat different from Ramon's. We believe that the investment management world can be broadly divided into three categories; large multi-strategy firms that run long-only and hedge fund strategies, traditional long-only managers who run no hedge fund strategies and finally hedge funds that run long-only strategies. To date, there has been limited participation in the 130/30 business by hedge funds. In the US, one of the largest impediments has been that pension schemes require that their long-only managers to be registered with the Securities and Exchange Commission. Additionally, hedge funds are often smaller organisations that do not have the infrastructure of traditional money managers. Finally, if you have a capacity concern and you're earning 2 and 25, you may not want to launch a product with substantially lower fees. We've seen two different fee structures. One is the asset-gathering structure, which has been typical of the long-only world. In this structure you get an increased fee because more assets are managed. The other is the hedge fund structure, where you charge a base fee and a performance fee with a variety of hurdle rates.
Andy Barber: Most pension funds are still on fixed fee, but there's an increased desire to embrace performance fees. It's not unusual to find that, particularly in a high alpha account, pension funds have adopted performance-related fee structures.
Gerry Paul: In our long-only services we see an increasing desire on the part of clients to be on a performance fee, to pay when value is added, which lays a foundation for that pricing scheme inside 130/30 services as well. It's got to be a relative performance fee. I don't think anyone's going to pay you a fraction of the beta, as they do with hedge funds.
John Delaney: We're seeing more people trying to charge a performance fee and a fixed management fee. If these funds are deemed to work and alpha's generated - and Andy's point partly plays to the fact that if you're separating alpha from beta and identifying skill - then you should be prepared to pay for it.
Ramon Tol: I have seen some data on fees for my research project and I wonder if some of the short extension product providers don't charge too much for the additional active risk. However, I will need to have a closer look at this before I can make any further conclusions.
Andy Barber: In the UK, in the long-only space it's more of a bunching of fee levels. In 130/30 there's a wide range of fees being charged and I hope fee levels end up closer to long only fees, [while] providers hope they end up closer to hedge fund fee levels! The compromise might well be that some sort of performance fee meets the objections of the pension funds who are paying too high a level of fee.
Alex Beveridge: At what point do you think allocations to 130/30 will move from exploratative to really meaningful?
Gerry Paul: They tend to be small pieces of overall asset allocation, almost exclusively sourced from long-only, so they're not competing with alternatives. It's viewed as a substitute for equities. We're at a very formative stage for these sorts of strategies. If we begin to see some real evidence among manager returns that this is a better mouse-trap and that you can, on a risk-adjusted basis, do better through equity extension services than you can through long-only, you'll see that allocation grow over time.
Alex Beveridge: Andy, how long before you would be happy to recommend more meaningful allocations to 130/30?
Andy Barber: It'll happen gradually over time, whether it's 12 months or four years, clearly different pension funds will take different attitudes to it. I feel fairly sure there'll be greater use of 130/30 strategies in four years' time than there is now, but [as to] the extent of that acceleration, I'm not sure.
John Delaney: In some cases, allocations are at the 5% level, which we would judge to be meaningful. If these are transitional types of trades, moving out of long-only into a sub-bucket of long-only type money and they know the managers, they're confident of the alpha process and signals, they're going to be more willing to make a meaningful allocation.
Andy Barber: I'd put 5% in the exploratory category. If you have 50% in equities, for the sake of argument, and only 5% in extension strategies, to me that's still exploratory.
Susan Kenneally: Our research shows that a lot of those 5% type allocations have been through a diversified 130/30 portfolio and that the exploration is moving up the tracking error in trying to get more alpha. In that space they're a bit more tentative.
Ted Roman: A major US public pension plan expects to move approximately 10% of its active large cap core to 130/30. This represents an allocation to 130/30 of approximately US$1bn. This decision represented somewhat of a sea change: it was a substantial investment decision moving from indexing or enhanced indexing, to 130/30 with an index vendor. If this decision turns out to be successful, it may prove to be a meaningful change to the view of 130/30 in the US. We have also seen a meaningful number of allocations from Dutch pension schemes to 130/30, in terms of the numbers of dollars, not necessarily the percentage of assets.
Alex Beveridge: I just want to discuss the different styles used by the 130/30 providers. We've spoken about the quant managers and their performance in August.
Ramon Tol: Yes, obviously the quant firms suffered quite a lot, not only in August, but in July as well. There are also a lot of fundamental shops which offer an extension strategy and some of them are doing quite well with reasonable performance We've also seen a couple of 130/30 managers which do the stock selection modelling using a quant process and then use a fundamental overlay in portfolio construction. I call this a 'quantimental' approach.
Alex Beveridge: Good coin of phrase there. John, do you have any advice for the readers on the different styles and tactics that are being used?
John Delaney: We're certainly talking to more people who are looking from a fundamental perspective. The fundamental guys need to prove to themselves and their organisations they can do this, but there are more and more people who seem to be doing well, so I think we'll see more fundamental styles coming out. There are also some people that think more niche-type strategies like emerging markets might have application to this type of product, so I wouldn't be surprised to see some of them come out shortly too.
Gerry Paul: The fundamental/quantitative distinction is an important one. But one of the outstanding questions is whether or not equity extension services have a style or should be tagged with a particular style. It's an interesting question to me as a value manager. Is 130/30 just 1.6 times exposure to value as a style? Are you amplifying style wagers with portfolios of this type? We don't believe that's true because we find little correlation between the alpha we generate on the long side of the portfolio, and post-portfolio construction, the alpha to be generated on the short portfolio. One related area we haven't talked about is the way you can control risk inside a 130/30 service - how it gives the portfolio manager more freedom to control unwanted exposures. It's an interesting area to explore. Can equity extension add more value than long-only in a more style-neutral way or with less style amplification?
Ramon Tol: In terms of portfolio "activeness", you could say there are two groups. You have the 130/30 managers who lever up their long-only product, the portfolio remains concentrated and you hardly see any increase in the information ratio, because the increase in alpha is matched by an increase in risk. On the other hand, you have the guys who create a more diversified portfolio, and that should lead to an increase in the information ratio, assuming the manager is skilful of course. This comes back to whether these funds are value, growth or style-neutral? Given the fact that the bulk of managers who offer these types of products are quant shops, you would expect a slight value bias in these portfolios.
Gerry Paul: It will be interesting to see how a purely fundamental manager approaches this, because earlier we were talking about constraints on short selling and hard-to-borrow stocks, and managing that constraint requires at least some quantitative element to your process. The manager has got to be able to find a substitute should a desired short sale turn out to be too expensive, either after you've committed research resources to it or while it's in your portfolio.
Alex Beveridge: Finally, is 130/30 truly a new investment paradigm, like some people are saying it is? Or have the marketeers just got hold of a new product they can push?
Ted Roman: It is our opinion that it is not marketing-inspired, because if it were, it would not have as long a life span. We believe that it is a broader approach to the long-only process, that it fits firmly within the long-only allocation, as opposed to the hedge fund allocation, and for those managers who can produce alpha, it is an important opportunity. We've seen 130/30 in fixed income, in real estate and we're beginning to see it in commodities. This is just the beginning of looking at reducing constraints across asset classes.
John Delaney: Paradigm is a little bold in terms of redefining the way people manage money. It's quite simply a slightly enhanced investment process by increasing the degree of freedom for the manager. But it has been marketed a lot and the opportunity to add alpha gets people interested. It's certainly captured people's imagination but I don't think it's re-writing the rule-book in terms of how money's managed.
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The Pension Protection Fund (PPF) has conceded it does not have "all the data we need to calculate" the impact of last month's ruling that some benefits may be unlawful.
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Dutch custodian KAS Bank has created a fintech solution to help schemes save on costs and improve transparency of currency hedging strategies.