We see so many reports these days of new 130/30, 120/20, (1X0/X0) launches that we’ve essentially stopped posting them in the scrolling “alpha ticker” at the top of your screen. Suffice to say, if your asset manager has a pulse, its probably launching or talking about launching some sort of “short extension” strategy.
But this article by Thomson IM about Investec’s new 130/30 and 120/20 funds raises an interesting question about the primary value proposition of 1X0/X0 funds. The article is titled:
Investec launches high conviction Global Extension long/short strategy
New fund will give manager James Hand the ability to back himself and turn standard long only fund into 120/20 or 130/30 strategy
The article draws on a veritable fruit salad of alpha-centric buzzwords to describe this fund. Most, but not all, are synonymous. While terms like “short extension”, “130/30”, “120/20”, and “long/short” essentially mean the same thing, we don’t think such a fund necessarily involves “high conviction”.
To be sure, fund manager James Hand probably aims to manage the fund in a highly-focused and concentrated manner. But to say that a fund is highly concentrated simply because it can go short is technically inaccurate and opens the door to 130/30 pretenders.
Firstly, there is nothing to say that 1X0/X0 is a necessary pre-condition for high conviction. Highly concentration funds have been around a long time (arguably pre-dating indexation itself). After all, if a manager believed strongly in only one stock, he was always theoretically free to invest 100% of the fund’s assets in that single stock.
Removing the so-called short constraint now allows such a manager to make an additional bet. Now he can take a short position in another stock using the long position for part of the collateral. Is he more concentrated than before? Or less?
He might very well have less beta exposure than before since the embedded equity beta in the short position might cancel out that which was baked into the long position. So an argument could be made that the fund would be even less correlated to equities as a result – and thus more concentrated in some risk factor other than market beta.
But ironically, such a long/short fund is actually more diversified. In other words, the manager is actually showing less conviction to his initial long pick by adding a second (short) position.
Certainly, one might also argue that since the new fund has, say, 200% gross exposure (2x leverage), the manager is just as wedded to his initial long position even after he adds the short position. This may be true in absolute terms, but there is no escaping the fact that the manager’s paycheque would now be dependent on two positions, not just one.
One might also say that the extra proceeds from said short position might be used to increase the size of the initial long position. Surely, that would amount to a “higher conviction” than the original long-only fund, right? While this may be true, this higher conviction is actually a result of the leverage generated as part of the short-selling process, not from the short positions per se. In other words, this leverage might just as well have come from a simple margin account.
Furthermore, if you view a 130/30 portfolio as a market exposure (100) and a market neutral overlay (30/30), then it becomes apparent that the fund needn’t be very concentrated at all. In fact, the number of positions in the 30/30 overlay may be as large – or larger – than the number of positions in the beta portion itself.
Therefore, if you’re looking for a concentrated fund, don’t assume that 130/30 fund necessarily fits the bill. In the end, a particular 1X0/X0 strategy might not actually be “high conviction” at all. The irony is that 1X0/X0 strategies actually represent a way for managers to express more of their beliefs, not to necessarily express those same beliefs with a “higher conviction”.