Morningstar’s Deutsch: 130/30 “not monolithic” but does represent a “convergence” in money management
Jan 1st, 2008 | Filed under: 130/30, Guest PostsWelcome back. Today, we bring you another in our ongoing series featuring the thoughts and perspectives of members of the CAIA (Chartered Alternative Investment Analyst) Association. You may recognize the name Steve Deutsch from recent media articles on 130/30 investment vehicles. Deutsch is Morningstar’s resident expert on these vehicles and therefore has a bird’s-eye view of the sector and its recent performance. Below, Deutsch draws on his company’s extensive database to take a closer look at the 1X0/X0 phenomenon.
ALTERNATIVE VIEWPOINTS (powered by CAIA):
Some perspective on 130/30 funds, a year into the “(r)evolution”
Special to AllAboutAlpha.com by Steve Deutsch, CFA, CAIA, Director of Collective Investment Trusts/Separate Accounts, Morningstar, Inc.
Despite all the excitement about short-extension strategies, 130/30, 120/20 and other constrained ratio investment products are not that monolithic or revolutionary (Morningstar refers to them simply as “leveraged net long”). Contrary to popular assumption, most are not purely quantitative. Nor are they the sole domain of mutual fund companies and retail investors. And given their short histories, many remain unproven. As a result, it is far too early to determine if these vehicles will reach $2 trillion (or even $1 trillion, for that matter) in the next five years.
Not Monolithic
130/30 is a shared investment strategy, but that’s not a basis for large categorical conclusions. It’s misleading when money managers or the media make broad general conclusions such as “130/30 strategies did well (or poorly) in the early days of the credit crunch market downturn.”
Sharpe’s law of performance attribution has been cast aside in this discussion. As always, performance is driven by an investment vehicle’s underlying assets. In the Morningstar databases we have seen these strategies predominantly invest in ”large blend” assets. But we also see mid- and small-cap, corporate and government fixed income, and international varieties of these products. Below are some randomly selected strategies, for both institutional and retail investors, with recent net portfolios presented in a Morningstar ownership zone analysis. The “centroid” indicates where investments are concentrated, while the ellipse shows the range of holdings in each 130/30 net portfolio. (Note that the selected money managers actually have very diversified leveraged net long holdings.)
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Nice summary analysis.
I wonder about two points, however:
“…the only way to generate Alpha is … with increasingly large amounts of leverage.
No, leverage can magnify the impact of manager skill, but it cannot create alpha where none exists. If the manager is a lousy long-only manager, his process is unlikely to add value with the ability to lever his insights.
“In examining the ‘investment approach’ narrative provided … I perceive four different varieties of leveraged net long investment vehicles”
I’d recommend taking these things with a large grain of salt. You can be pretty sure that virtually every product will employ a screen for both desirable and undesirable characteristics, but different funds might prefer a trait that others shun. Then, *most* PMs will apply their additional impressions, using notions that are impossible to backtest, in tweaking the final portfolio. Of course, you’ll seldom see “subjective judgement” as one of the key criteria emphasized.