130/30 Mutual Funds have been en vogue for a few years now given the prospect of enhanced returns above and beyond broad market performance without the formal use of leverage.
What is a 130/30 Fund?
Basically, a fund manager employs a strategy whereby they start with a baseline of 100% of a fully invested portfolio, they short 30% and invest that additional 30% (with the cash proceeds from the short side) in the long portion of their portfolio. The end result is a 130% Long position and a 30% Short position. While the net amount invested is still 100% of assets (no external leverage required), the goal is to have shorted assets that are believed to underperform the market and go heavy (30% extra market-weighting) assets that are believed to outperform the market. If the fund manager is right, even with a very small positive alpha (performance above and beyond the expected market return due to asset management skill – not luck), the internal leverage employed by being short marginal losers and long marginal winners can produce hefty returns above the benchmark which is typically a broad market index like the S&P500. Over a long investment horizon, even annualized 1-2% returns above benchmark can make a 6-figure difference for even a middle-class investor in retirement that put away a few grand a year for 30 years (see what happens to the 25 year old investor vs a 35 year old investor starting out).
This 130/30 theory sounds great, and investor funds have poured into various 130/30 funds over the years chasing these market beating returns. The problem is, many of these funds have not lived up to expectations and they often carry higher fees to boot. The financial crisis certainly didn’t help, since many of these funds were LONG Financials when all hell broke lose. When the entire market is tanking and investors are unloading everything at firesale prices, it’s tough to discern what to short and what to buy. Fundamentals and rationality broke down; heck, even the price of gold vs weak dollar correlation broke down which is a rarity.
130/30 Mutual Fund Performance
Using the S&P500 as a benchmark, even though some of these 130/30 mutual funds rely on various asset classes, below is a comparison of how you could have done as opposed to just investing in a standard low-fee broad market index ETF like SPY. The only 130/30 mutual fund that routinely beat SPY over the recent time periods was BNY Mellon US Core Equity 130/30 Inv (MUCIX). The others are from various other fund families and did not outperform. Note however, that the 130/30 ETF CSM (below) outperformed even this mutual fund over multiple time periods.
130/30 ETF – ProShares Credit Suisse 130/30 (CSM)
In looking at various time periods of CSM vs. its competing mutual fund brethren and the S&P500, CSM wins out most of the time. While its performance history is relatively meek, if you’re a believer in the 130/30 rationale and use historical performance to help judge the prospects of future returns, CSM may be the optimal selection.
130/30 ETN – KEYnotes First Trust 130/30 LgCp ETN (JFT)
Aside from the fact that Exchange Traded Notes (ETN)s have some constraints and risks that ETFs don’t like the credit risk associated with the issuer, ETNs often have massive tracking errors or very low volume. Take this gold ETN that returned 421% in a single month when the price of gold bullion barely budged. Not that investors were complaining on the way up. But when it corrected, the herd was slaughtered. That bring us to JFT. The performance is rather jumpy and while roughly correlated with the other 130/30 players over long periods, the volume is so low, it barely trades at all on some days and the bid/ask spread was a whopping $3 today (10% of the share price!), making it completely unsuitable as an investment in my opinion. I won’t even pay a load on a mutual fund, let alone a 10% spread commission. Frankly, I don’t know why it’s trading and who the traders are, but I’d prefer to rely on CSM over JFT any day.
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