Those unfamiliar with the inner workings of a parliamentary democracy always find the hoots and hollers accompanying parliamentary debate to be a source of great entertainment. Every week in countries around the world various prime ministers subject themselves to intense, direct and sometimes vicious attack. Some countries (such as Canada) have laws actually protecting legislators from libel suits for whatever barb they throw at their fellow parliamentarians while inside the house.
On Thursday, the Canadian chapter of AIMA, the Alternative Investment Management Association held its annual parliamentary-style debate in Toronto. This year’s resolution before the house: “1X0/X0 hybrid hedge fund strategies are simply a marketing fad.” With more than a passing interest in 1X0/X0 strategies, we were sure to show up for the fireworks.
“Speaker of the House”, AIMA Canada Vice Chair Tris Lett was tasked with maintaining decorum in the oak-paneled main dining room of Toronto’s tony National Club (think, the club from the movie Trading Places). Clearly familiar with the mayhem of parliamentary debate, he warned debaters only against physical attacks and the use of foreign objects (a la the Taiwanese parliament).
Watson Wyatt’s David Gold flew in from New York to argue in favour of the resolution – that 1X0/X0 was indeed a marketing fad. Arguing on behalf of her majesty’s loyal opposition was Dr. Jean Masson, Head of Quantitative Research at TD Asset Management and the chief quant behind TDAM’s 130/30 platform (see related news).
Gold should be congratulated for taking on a job that fewer and fewer experts want – standing in front of the 130/30 freight train. But he did an admirable job by arguing not that the 130/30 “fad” would eventually give way to traditional long-only investing, but that the fad would end with the primacy of “pure alpha sources” like hedge funds over “half-way” alpha/beta strategies such as 1X0/X0. This approach took a large measure of the wind out of Masson’s attempts to brand Gold as a financial luddite.
130/30: A Cabbage Patch Kid?
In order to define a true fad, TD’s Masson fondly recalled his childhood toy, a Cabbage Patch kid. Now Cabbage Patch kids, said Masson, “That was a fad!”. It involved a small group of people, occurred over a short period of time, and having “no political, social, or economic significance”. 1X0/X0 did not fit this definition, he argued, and was therefore not a “fad”.
Why paint the old truck when you can buy a new one?
Gold’s remarks echoed somewhat of love/hate relationship Watson Wyatt seems to have with short extension strategies. In January of this year, the firm sent a memo to clients in which expressed hesitation over 130/30 strategies (see IPE article “Watson Wyatt Nervous over 130/30 Funds“). And last year, the firm hosted a webcast called “130/30: Holy Grail or Guaranteed to Fail?”
Yet the firm stopped short of recommending against 130/30 (see related posting) and in a webcast last October Watson Wyatt elder Roger Urwin declared that 130/30 had “breathed new life into asset management.” (see related posting)
Gold compared 130/30 funds to an old pickup truck that has been hastily refurbished and resold. The old truck, said Gold was a traditional long-only mutual fund. A new truck would be a portfolio of absolute return funds. “Why not just buy a new truck?” he asked the house.
130/30: The Roger Clemens of Investing?
Masson countered that a full portfolio of hedge funds wasn’t just a new truck. It was a helicopter – way too much for the average investor. In reference to how 130/30 funds are a step in the right direction Masson retorted, “Just because you can take a helicopter form A to B doesn’t mean you don’t need a road system!”
Clearly not finished with colourful analogies, Gold shot back that – with all due respect to Roger Clemens – 130/30 was just long-only on steroids. So why not just get a better athlete instead?
Masson had a comeback for that too. Apparently the guy used to work in the medical field. So he launched into a litany of benefits of appropriate and responsible steroid use to cure various ailments.
130/30: Actually “performance-enhancing” anyway?
Gold suggested the 130/30 pick up truck performed worse than both the old truck (S&P 500) and the new truck (the HFRI Equity Hedge Index). While we’re prepared to believe that 130/30 may have been recently dragged down by the ball and chain of its beta exposure, we were surprised to hear that 130/30 had also underperformed the market. On closer examination, however, Gold’s conclusion is based on a comparison of the S&P 500 and the new “Dow Jones RBP 130/30 Index”. Regular readers will remember that that index (like S&P’s similar offering) is just one particular quant model (the “RBP” model) run using 130/30 exposure. In other words, it’s not a representation of actual 130/30 funds.
When pressed on this point, Gold said there just weren’t enough real 130/30 funds to draw any definitive conclusions.
(By coincidence, we had just updated Gordon Johnson’s comparison of “sister” 130/30 and long-only funds, which suggested that adding a short extension might increase returns ceteris paribus. In fairness, Johnson’s analysis is based on a small handful of funds. So it’s likely that neither approach can provide any definitive answers at this point.)
Bottom line: really removing constraints?
130/30 strategies are often described as a removal of the “long-only constraint” (see related posting). But Gold argued, effectively, that that’s the only removed constraint. In fact, 130/30 faces a new set of “constraints” such as the requirement to maintain a beta 1 net exposure, the requirement to short 30% and, ironically, the new requirement to be long 130% (not a far cry from the initial constraint to be long 100%)
In the end, this summed up Gold’s argument – that 130/30 was essentially what Angelo Calvello of Man Investments has called a “Truck Stop on the Way to Portable Alpha”. And if that makes it a “fad” then maybe he’s right.
The Speaker concluded the proceedings by asking the 150-odd in attendance for a show of hands in support of the motion that 130/30 was a fad. But notwithstanding David Gold’s valiant efforts, the motion was soundly defeated.
And so 1X0/X0 lives to fight another day. No hooting, hollering, fighting or foreign objects. Maybe next year they’ll do better.
Disclosure: Alpha Male has recently given a presentation on three continents called “130/30: Not a Fad!”. So there’s a small chance he might be biased.