Fahrenheit 130/30

9 March 2007

So called “130/30″ strategies have been bubbling up in the asset management community for some time now.  But things boiled over with the release of Merrill Lynch’s report on Tuesday - moving 130/30 from the industry rags (like this one) to the mainstream (UK, Canada, US).  In that report, Merrill Lynch said:

“We are expecting a wave of asset managers to begin offering “130/30” portfolios this year, as the gap between traditional managers and hedge funds continues to narrow…fundamental managers and hedge funds are increasingly offering or considering the portfolios.”

Buried in all this newfound fame is the story of 130/30’s previous life as a long-bias hedge fund.  So we find it somewhat ironic that investors and advisers who have hitherto avoided hedge funds like the plague are now espousing the virtues of 130/30.  The recent hype is obfuscating the truth about 130/30: it’s simply another marketing package delivering an ETF and a hedge fund.  In other words, 130/30 is simple alpha-centric investing, not some new asset class.

Merrill makes this point near the end of their report:

“We have described 130/30 as a bundled product, offering both a ‘beta one’component and a long/short, ‘alpha’ part. Whilst we see why this packaging would be popular, and makes sense in terms of reducing constraints on fund managers. We also wonder whether an adoption of 130/30 may be a prelude to a more thorough separation of alpha and beta. There is, for instance, an argument that in many markets you could look at a combination of an index fund for beta one exposure without any pretence at alpha generation, and a long/short fund.”

We just don’t see the difference between 130/30 and buying a “beta one” ETF with a market neutral hedge fund as a side dish (as in, “You want fries with that?”).  Aside from a few academic arguments, the debate about 130/30 is one of perception, not reality; communication, not substance; and marketing, not finance.   

For example, several times in its report Merrill Lynch reveals the psychological motivations behind 130/30 (our emphasis):

“In terms of market positioning, there is something to be said for an approach which can be seen as “long plus” rather than “hedge minus”. 300/200, we think, would very readily be seen as an aggressively leveraged long/short fund with a long bias.”

“One phrase we have heard in discussions of 130/30 is “baby steps”; the idea that it represents an initial, tottering move away from long only towards more adventurous approaches.”

“A few years ago, people tended to draw a line in the sand at shorting and usage of derivatives. Increasingly, this strikes us as archaic. Broad, mainstream acceptance of 130/30 would provide further proof of this view.”

“As we have pointed out already, 130/30 is still a beta one style. The important psychological point here is that investors will still, therefore, have a pretty good idea about what their investments will behave given any particular move in the equity market.”

“Largely as a consequence, owning a 130/30 product is less scary than owning a more heavily hedged vehicle.”

The report is also refreshingly frank about how 130/30 amounts to what we call a “marketing package” containing alpha and beta.

“The proliferation of 130/30 portfolios are a natural outgrowth of the continuing demand for alpha beta separation, in our view. They show the narrowing gap between traditional long-only managers and hedge funds, as some traditional long-only managers lean toward demand, and try to adapt tools such as shorting to offer more flexible strategies.”

Merrill Lynch also predicts that 130/30 will eventually be a substitute for long-only investments (vs. a substitute for absolute return strategies).   

“A related risk to 130/30 portfolios is that some will view them—mistakenly—as absolute return portfolios. They are in fact high-conviction long portfolios, but their use of shorting may confuse some, and some may mistakenly view them as narrow niche substitutes for absolute return. Eventually however we believe they will be increasingly substituted for long-only mandates.”

But the truth is that 130/30 is a substitute for neither.  It’s a half-way point that allows long-only managers to sell hedge funds without being “scary” and for hedge funds to take a piece of the (far bigger) long-only pie.  And while it’s step in the right direction, it’s certainly not a new idea - no matter what the marketing tells you.   

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5 Responses to “Fahrenheit 130/30”

1. pb273 Says:
   March 14th, 2007 at 4:20 pm

   Any idea who first came up with the term 130/30 or 120/20 or 1X0/X0 ? Was it Merrill Lynch or Goldman Sachs ?

2. Alpha Male Says:
   March 14th, 2007 at 4:36 pm

   No idea for 130/30, 120/20 etc. We just pulled “1X0/X0″ out of our collective butts here at AAA, but perhaps it was already out there too…

3. All About Alpha » Blog Archives » State Street runs up the score in 130/30 March Madness Says:
   March 26th, 2007 at 10:30 pm

   […] There has been a flurry of activity in the 130/30 space so far this month that seems to rival the hoopla over US college basketball.  No sooner had Merrill Lynch released its report on 130/30 than State Street landed a 165 million GBP 130/30 mandate from Britain’s Asda Group.  With some industry insiders saying the current size of the US 130/30 market is US$50b AUM, that would be nearly 0.7% overnight growth had it happened on that side of the pond.    […]

4. allaboutalpha.com: Welcome to AllAboutAlpha.com Says:
   April 20th, 2007 at 8:14 am

   […] Regular readers may recognize chart from papers discussing the similar concentration of equity indices. For example, this one from Merrill Lynch’s recent 130/30 paper: […]

5. allaboutalpha.com: Welcome to AllAboutAlpha.com Says:
   May 14th, 2007 at 8:48 pm

   […] While I don’t necessarily see 130/30 as the “worst of all worlds”, I do agree with Roger that 130/30 bears a remarkable similarity to the failed beta-plus strategies of old.  (see related posting: Fahrenheit 130/30). […]