130 / 30 – the new black?
Tommy Adams
Steven Beveridge
Agenda
1. What are they trying to achieve?
2. How did they arrive?
3. 130 / 30 and UCITS III
4. Can anyone do it?
5. Is the market ready for it?
Part one:
What are they trying to achieve?
What’s in a name?
• Aliases:
– short extension, leveraged alpha, active
extension, extended equity, 1X0 / X0
• Not a strategy in itself
• Not an absolute return approach
• Stepping stone to a hedge fund
What does 130 / 30 mean?
Long Exposure
Traditional
Long Only Fund
100% market
exposure
Long portfolio
0% market
exposure
Short Exposure
• Traditional long fund - £100
• Borrows £30 of stock and sells ‘short’
• Reinvests £30 premium in best ‘long’ ideas
• 100% net long
• 160% gross exposure
Greater freedom and greater conviction
• Allows managers greater
flexibility to express their
views and add alpha in
Least
favoured
stocks
Best ideas
two ways:
Overweight
– Least admired stocks
can be expressed as
Underweight
5% short rather 0.4%
underweight
– More capital directed
towards ‘best ideas’
Traditional long only
130 / 30
Increasing the alpha opportunity
• Alpha generation still comes from stock picking
ability - both long and short
• 130 / 30 removes some constraints of long only
• But still relatively constrained in comparison to say
most long short hedge funds:
– net 100% long
– extension part is market neutral
– gross 160%
• So relatively benign way of increasing alpha
opportunity
Equity product spectrum
Index /
ETF
Enhanced
Index
Style
specific
Focussed
Active
extension
Long bias
HF
Low net
HF
Equity
market
neutral
Increasing tracking error
Relative
return
beta
Absolute
return
alpha
Why 130 / 30?
• 110 / 10
• 120 / 20
• 130 / 30 – optimal risk reward payoff
• 140 / 40
• 150 / 50 – max leverage allowed under UCITS
Part two:
How did they arrive?
US origins
• First short extension fund launched 2002
• But only joined by a handful prior to 2006
• US investors > $50bn now
• Mainly institutional and family office interest
• Some 15% of US institutional investors invest in
130 / 30 funds (Source: Vodia Group)
Growing number of products
• Currently most still run as
segregated mandates ..
• .. But rapid rise in mutual
fund offerings
How have they performed so far?
• So far so good ..
• .. but not enough funds
have been around long
enough ..
Source: eVestment Alliance
Driving forces behind 130 / 30
• Institutional led demand for higher conviction
strategies and alpha generation
• Fusion of traditional and alternative investment
techniques – ‘hedge-lite’
• Hedge fund providers as well as traditional longonly managers see opportunities
• Differentiation by geography and asset class
• Facilitated by UCITS III regulations
Part three:
130 / 30 and UCITS III
UCITS III
• 130 / 30 is a specialist high alpha fund
• Offshore or onshore
• Daily pricing
• Investor eligibility
– Institutions – private banks, Fund of Funds, Discretionary
Managers, Portfolio Bonds (Hong Kong)
– Available to ‘specialist’ retail market in UK and can be ‘passported’ cross-border
– Don’t have to be qualified investor
– No large minimum investment levels
UCITS III
• Gearing
– Gearing through swaps - gross exposure is
limited to 200% of Fund NAV (130 / 30 = 160% so in theory could have 150 / 50)
• Shorting
– No physical shorting allowed within UCITS III
Fund – (Irish Financial Regulator has changed stance!)
– ..but synthetic shorting can be achieved by
Portfolio Swap / Contract for Difference held by
the Fund
Typical swap terms
• Governed by ISDA between Fund and Swap
Counterparty
• Fund pays ‘LIBOR + X’ bps for long exposure
• Fund receives ‘LIBOR – Y’ bps for short exposure
• Initial margin with variation margin popular
• Cross margining of positions within swap to
minimise collateral requirements
• Monthly and forced resets (important for UCITS
counterparty exposure limits)
• Can ‘trade away’ with any (approved) broker
Assets held by Fund
• All assets held with
custodian
• Valuation and fund prices
The Fund (UCITS III)
by Fund Administrator
• Basket of stocks within
Cash
Portfolio
Swap
Long and short
exposure
Physical
Stocks
Long only
one OTC swap (long and
short exposure)
• Swap will reflect M2M
value of underlying
securities less financing
costs
Example portfolio 1
100% physical stocks plus swap
30% long
30% short
• Separate reporting to be
consolidated
• Minimises financing costs but
incurs custody fees
100%
long
• Daily risk management / UCITS III
compliance monitoring more
onerous, with separate part of
portfolio
Physical
stocks
Swap
‘wrapper’
• Stamp duty trading costs (for
long UK stocks)
Example portfolio 2
In practice: 80% physical stocks plus swap
• Allows for cash reserve for
any margin requirement
50% long
30% short
• Vary %age physical stock held
(dependent on factors such as
markets)
80%
long
• Allows Fund to take
advantage of dividend
enhancement opportunities
Physical
stocks
Swap
‘wrapper’
for long positions on swap
and transaction cost
efficiencies for UK positions
Example portfolio 3
100% cash plus swap
• Operational simplicity
• Consolidated reporting facilitated
• Simpler risk management
130% long
• Efficient UCITS III compliance
monitoring
• Swap financing on total balances
30% short
• Counterparty exposure may be
greater (monthly resets help to
Swap
‘wrapper’
manage this) – limit 10%
Risk management
• Sophisticated user of derivatives: the OTC
derivative is used for investment purposes
• VaR analysis used to monitor swap risk exposure
e.g.:
– Absolute VaR calculated daily (<5% of Fund
value, 99% confidence interval, holding period 1
day)
– Relative VaR (relative to benchmark index)
checked quarterly
• Risk Management Process (RMP) document lodged
and approved with Financial Regulator
Part four:
Can anyone do it?
Can anyone do it?
• Increased Alpha potential with similar risk
• Conviction led portfolio
• Shorting skills are paramount
• Many have tried and failed
Alternative Investment Techniques
• Opportunity for hedge fund managers to widen
distribution
• Cartesian Capital UK Boutique
• Previous hedge fund experience
• Recognised shorting credentials
A different skill-set
Good
• Buy signals may not
Bad
Growth
Market position
Free cash flow
Financial strength
Restructuring /
recovery
Corporate activity
Long position
Aggressive accounting
e.g. revenue recognition; policy changes;
off balance sheet liabilities
Low earnings quality
e.g. divergence of declared profit; cash
generated; tax paid; recurring
exceptionals; unsustainable margins
Financial weakness
e.g. on and off balance sheet debt; large
working capital requirements;
overdependence on short term facilities;
pensions; leases
Short position
necessarily be used
as sell signals
Cartesian 130 / 30
 Launched November 2007 – Dublin UCITS
 Number of holdings:
~75
– circa 55 long and 20 short
 Maximum Long per individual stock
10%
 Maximum Short per individual stock
5%
 Aim to keep exposure at 160% although flexibility to
be in the range 100 – 160%
 Min / Max net long exposure
– Aim to keep net long exposure at
90%-110%
100%
Future Developments at Resolution
• Ideas in the pipeline
• Managers in other asset classes with shorting
experience
• Rigorous product development challenge process
• Roll out later in 2008
Part five:
Is the market ready for it?
Is the market ready for it?
• Developed in the US for Institutional demand
• Growing awareness in UK
• Pension Funds investing from equity allocation
• Retail demand for Alpha.
Considerations for Retail Market
• Market Research
– IFAs
– Consumers
• Level of understanding
• Support
• TCF obligations
What did we find out?
• Clearly a new concept for many
• Alpha angle has generated interest
• Keen to find out more
• Consumers – Yes as part of a balanced portfolio
• Key emphasis on education
The new black?
• Institutional interest proven
• Retail wait and see approach
• Is it the new black?
Wouldn’t go that far but…
• We see it as part of ‘purple’ future
Disclosure
This presentation is for professional clients and investment professionals only and should not be relied upon by retail clients.
This document does not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase any investment, nor
shall it or the fact of its distribution form the basis of, or be relied on in connection with, any contract for the same.
Cartesian Capital TM and the Cartesian Capital logo are trademarks owned by Resolution Investment Services Ltd and are
used under licence by Resolution Fund Managers Ltd.
Cartesian UK Equity 130/30 fund is a sub fund of Resolution International Funds plc, an open ended company investment
company incorporated in Ireland.
The value of the investments and any income from them can fall as well as rise and is therefore not guaranteed. Exchange
rate movements may cause the value of overseas investments to fluctuate.
Issued and approved by Resolution Investment Services Limited authorised and regulated by the Financial Services
Authority. Registered in Scotland No. SC101825. Registered office: Resolution House, 50 Bothwell Street, Glasgow,
G2 6HR, Tel 0141 222 8000.