130/30 has “opened up serious questions” for brokers and custodians: report

130/30 13 Feb 2008

A survey from consultancy Vodia Group backs up previous surveys from Merrill Lynch and AllAboutAlpha.com by finding that roughly 15% of institutional investors currently invest in 130/30 funds.  As a result of expected growth, Vodia anticipates major changes in the prime brokerage and custodian businesses.  According to the firm’s press release:

“130/30 has opened up serious questions in the division of business between brokers and custodians. While there have been disagreements between brokers and custodians looking to partner, the opportunity is too new to have generated any long-term damage. This issue will become more pronounced as 130/30 grows in importance and as client relationships are deepened through the provision of new services.”

Apparently life won’t be all that bad for prime brokers though.  According to a chart released by the firm, prime brokerage financing revenues will increase dramatically over the next 4 years – even as financing spreads come under pressure…  

  

  
130/30 Operations
 
So how operationally different is 130/30 from, say, 100/0?   To be sure, short-selling requires new processes and procedures, and long/short portfolios introduce new attribution analysis challenges.  So the question on the minds of prime brokers and administrators is how to position themselves for 130/30.

RBC Prime Brokerage chief Colin Bugler told Wall Street & Technology earlier this month that, “Investors are slightly skeptical that these long-only managers who have only ever held long equities actually have the ability or the technology to identify the short-selling aspect of this”

Bugler elaborates on some of the new issues facing prime brokerage customers.  Reports Wall Street & Technology:

On the technology side, traditional asset managers need to adapt to new things — like measuring their short-side risk, borrowing securities and factoring securities lending fees into their profit and loss — that they never had to cope with on the long side. Investors are going to want to see that these firms have expertise not only from an intellectual capacity, but from an infrastructure, technology, compliance, order management, and execution perspective as well, Bugler says. They may need to turn to portfolio management software designed for hedge funds, for instance. They may need to invest in new risk management systems that will capture short positions and value that risk appropriately; and technology that manages loans, collateral and securities lending fees.

If he’s right, then prime brokerages – which have a competency in these areas – ought to be among the most significant beneficiaries if 130/30 becomes the New Long-only as some have predicted.

130/30 Quant vs. Fundamental

For more on the operational implications of 130/30, check out the November/December edition of FTSE Global Markets magazine.  It contains a pretty good overview quoting several of the major players in the space.

The piece contains a couple of interesting observations on the quant vs. fundamental debate that rages within this community.  For example, Darrell Riley, head of global institutional marketing at T. Rowe Price, tells FTSE Global Markets:

“Quants are fine when there is good factor stability and when you combine that with 130/30, it’s fantasticBut when there is a turning point, they may really suffer.”

And Merrill’s Charles Shaffer (managing director and product manager for 130/30) questions the conventional wisdom that quants should be better than fundamental managers at running 130/30.  Reports FTSE Global Markets:

Shaffer says sceptics once claimed that only hedge fund managers, who know how to handle shorts, and quants, who employ rigorous risk management and a ready ranking of stocks, would be able to run 130/30 money well.  Experience has proved the naysayers wrong, however: fundamental 130/30 managers have beaten the quants hands down in 2007. ‘The conventional wisdom, particularly in the early days of product development, is often backwards,’ says Shaffer, whose team provides advice, analysis, prime broker and securities lending services to managers who run 130/30 portfolios.  

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