We admit to drinking a lot of our own Kool-Aid here at AllAboutAlpha.com.  So we actively seek out dissention and differing opinions as much as possible.  We had planned to bring you one such story about a manager who says investors “should be wary of [130/30] funds offered by large financial services institutions with affiliated brokerage and ending operations”.  But our friends (and AllAboutAlpha media partners) at Lipper HedgeWorld published a great piece on Kirchner’s thoughts late last week.  The article is for HedgeWorld’s premium subscribers only, but we have been given permission to bring it to you in its entirety below…  

“L/S Manager Says 130/30 Funds Create Negative Alpha”  

WASHINGTON (HedgeWorld.com)-”Investors may get alpha with a 130/30 fund, but it won’t be free. In fact, the cost may end up being prohibitive, according to one long/short equity fund manager.

Implementing 130/30 strategies creates negative alpha from the start, said Thomas Kirchner, a portfolio manager at Pennsylvania Avenue Event-Driven Fund, a Washington, D.C.-based mutual fund that practices short selling. On his blog, The Deal Sleuth, Mr. Kirchner posted a paper he wrote that stands in stark contrast to the recent hype around 130/30 products in the asset management industry.

In the post “Negative Alpha Is Built Into 130/30 Funds,” Mr. Kirchner wrote that the problem with 130/30 funds is that they invest all the money they have. So in order to short, they have to borrow. And that comes at a cost.

In theory, the manager of a 130/30 fund goes long using 30% leverage and then shorts the same amount, which gives the portfolio a total long/net exposure of 100%.

But in an interview, Mr. Kirchner said that most of the advocates of 130/30 funds prime brokers, asset managers and sell-side analysts fail to provide the whole picture. The investor, he said, is told that in addition to placing 100% of his principal in an index, 30% of the invested amount will be sold short, and that the proceeds of the short sales will be used to acquire a 130% long position. The net exposure is still only 100% and generates pure beta, while the long/short component of the portfolio is supposed to generate some alpha. That’s the concept.

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