S&P follows CS into 130/30 index business

130/30 20 Nov 2007

Following on the heels of Credit Suisse, S&P has now entered the burgeoning “130/30 Index” industry.  If you think the idea of an index of active strategies is a little weird, you’re not alone.  But this certainly isn’t S&P’s first active index (a.k.a. “strategy index”).  Here are some others.  And contrary to some reports, its not the first 130/30 index either (see related posting).

Most, including the new 130/30 offering, are based on the firm’s proprietary stock-ranking model called STARS.  Since 80% of 1X0/X0 providers are quants, S&P’s model serves as an interesting opportunity to see under the hood on one of these strategies.  In fact, the firm has published the entire methodology here (containing the following schematic).

 

But here’s the thing we don’t quite get: why would you want to benchmark yourself to another active manager?  There is no common risk factor underlying these funds that can serve as a benchmark.  There is no “130/30 beta”.  In fact, all a 1X0/X0 program aims to accomplish is to lever pre-existing alpha for greater returns if alpha is already positive or greater losses if alpha is negative.  As IPE reports, a speaker at a recent conference referred to 130/30 as just a “prescriptive technique”.  How do you index a “prescriptive technique”? 

That said, the STARS system seems to work pretty well according to its track record (contained in the methodology document).  It seems to boil down to the following (for longs):

  • “Calculate and take the difference between the current and one-year prior levels of external funding, defined as:
      • [Debt in Current Liabilities] + [Long-Term Debt] + [Common Equity] + [Preferred Stock] – [Cash and Short-Term Equivalents]
    • Deflate by the average total assets, 
    • Cross-sectionally standardize this measure by industry, replacing missing values with 0.
    • Multiply by -1 to arrive at the Long Basket Industry Relative External Funding (IREFL).
  • Calculate the current price-to-sales ratio, defined as: 
    • Closing Price/{[4-Quarter Sum of Net Sales]/[Common Shares Outstanding]} 
    • Cross-sectionally standardize this measure by industry, replacing missing values with 0. 
    • Multiply by -1 to arrive at the Long Basket Industry Relative Valuation (IRVL).
  • Sum IREFL, and IRVL to arrive at the Long Score. 
  • Rank each stock in the Long Universe by its Long Score. 
  • Take the top 30 as the Long Basket.”

Yeah, we know.  Not rocket science, eh?  And maybe that qualifies it as a good manager bogey – but a true “index”?

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