130/30 Not yet shining in Land of the Rising Sun

130/30 06 Aug 2008

In March 2007, Asian Investor reported that the dawn of 1X0/X0 investing was close at hand in Japan.

“Large Japanese fund managers are looking to develop their own hedge-fund strategies as their local clients increase their exposure to such products. One of the most talked-about of these now are 130/30 strategies, which involve a 130% long position and a 30% short position, with the proceeds from the short helping to pay for the additional long exposure.”

With several mega-institutional investors and a $120b public pension fund that has recently upped its hedge fund allocation, you’d think the sun would shine on short-extension strategies.

But this month, the magazine reports:

“…2008 was supposed to be the year when the giant pension funds of Japan began to experiment with active extension structures. So far, it hasn’t happened. And while fund managers flogging these quant products say it’s just a matter of time, the possibility that 130/30 strategies and their ilk never gain traction is something to consider.”

Asian Investor cites several reasons for the slow uptake.

Firstly, it says that many Japanese institutional investors view 130/30 as a sort of proto-quant strategy.  And like all quant strategies, it should be avoided.  Second, investors can’t figure out if 130/30 funds are hedge funds or long-only funds.  Third, Japanese investors are still trying to come to terms with risk control, and fourth, the fees are different than traditional long-only funds.

I asked Ted Uemae, President of AIMA’s Japanese chapter what he thought of these developments (or lack thereof).

He told me that the abysmal performance of the Nikkei last year was partly to blame.  With a return of -11.1% in 2007, Tokyo was the worst performing major developed country market in the world last year.   Says Uemae:

“…some of Japanese pension funds are said to start shifting part of their assets from Japanese Equity investments to Hedge Fund Investments…they want to decrease their original allocation to the Japanese equity market (shifting it to) emerging markets, funds of hedge funds, private equity or…(Japanese) hedge fund managers…”

Unfortunately, he notes, 130/30 is likely seen by Japanese investors as an extension of traditional long-only active management – bringing with it Nikkei beta.  So institutions may essentially be leapfrogging, in some cases, right to absolute return strategies to avoid market beta altogether.

Compounding this, says Uemae, is the usual hurdle of needing experience with shorting.

“…it is not at all easy in Japan for traditional managers to go short since they often do not have ample experiences in shorting operations. The 130/30 concept is really great, but practically, how short operations can be managed is the key.  If large-cap only, this should not be a problem.”

Asian Investor concludes that 130/30 may actually rise in China before it does in Japan.  But despite the expected theoretical benefits of applying a short-extension to Chinese long-only funds, this recent article says that certain challenges remain (very rough, but interesting English translation by Google here).

Last year, I gave a presentation on 130/30 in China and found that 130/30 was not a huge priority at the time.  But I felt that this was a result of local institutional investors being overwhelmed with opportunities and other priorities, not a detailed analysis of the pros and cons of 130/30.  In other words, it was as if they simply hadn’t gotten to it yet.

If 130/30 dawns on the multi-trillion dollar Chinese institutional investment industry, then the future for Asian suppliers will be so bright, they’ll have to wear sunglasses.

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