The so-called 130/30 strategy, which has gained a lot of attention among mutual funds, is now being unveiled in an exchange traded fund.
If the term is unfamiliar, it means investing 100% of the assets of a fund and going short 30%, and taking the proceeds from those short sales to go long an additional 30%. The strategy is to put that extra 30% in stocks that may outperform a benchmark index and sell short shares that ought to lag the same benchmark. The goal is to add alpha, or outperformance versus an index. The new
ProShares Credit Suisse 130/30
will try to add alpha by buying an S&P 500 Index fund.
The index underlying the fund will overweight certain S&P 500 components and sell short others, based on a proprietary model constructed by Massachusetts Institute of Technology finance professor Andrew Lo and Pankaj Patel, director of quantitative research at
. As there's been a lot of volatility, there is money to be made. S&P 500 members
have surged 161% and 111% this year, respectively, while
have tumbled 51% and 53%.
As the benchmark index for the fund is the S&P 500, it owns (or shorts) only stocks in that index. Because of that, there isn't much to glean from individual stocks; the single largest short accounts for only 1.3% of the fund. The sector weightings are more interesting. Of the 30% short, 19% is technology.
That's curious because the
iShares DJ US Technology Index Fund
has risen more than 30% since the March stock-market low, compared with the S&P 500's 25% gain. The fund also has large short positions in financials, consumer cyclicals and materials. Given the quarterly reshuffle, the fund is subject to heavy shorting in those sectors (except financials, perhaps). Problem is, those industries typically lead recoveries, which could be setting up the fund to lag. That all depends, however, on the shorting acumen of the process, and since it's proprietary, it boils down to faith in Lo and Patel.
There is also one important mechanics issue to be familiar with. The fund's 30% short and 30% "extra" long positions will come in the form of swap agreements and forward contracts, which create counter-party risk. That adds an element of uncertainty, even though ProShares have proven itself more than capable in this area.
The ProShares Credit Suisse 130/30 fund falls under the realm of actively managed funds. Most ETFs are static, save for price fluctuations of the components. This makes using ETFs easy because you know what a fund owns now and what it will own in six months. That attribute has contributed to ETFs growing much faster than traditional mutual funds during this decade. But that's not the case with actively managed products. One byproduct of building portfolios with actively managed mutual funds is that, because of the lag in reporting holdings, investors often ended up being grossly overweight in sectors, such as tech in 2000 and financials in 2007. ETF transparency mitigates that issue, but investors still need to take time to look at their fund holdings periodically.
The importance of that issue, or the lack of regard for it, will determine whether actively managed ETFs ever gain traction.
At the time of publication, IYW was a client holding.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
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