A recent change in regulation has now allowed fund managers responsible for UK domiciled vehicles to be more flexible with their investment strategies. As a result of this, we have seen the introduction of '130/30' funds into the UK fund market for the first time.
Prior to this new development, fund managers either had the opportunity to run long-only portfolios or full blown long/short hedge fund strategies; the 130/30 strategy resides between the two.
Traditionally, in a long-only portfolio, the manager cannot fully exploit a stock he does not like because the maximum it can be underweighted is the stock's weight within the benchmark. I.e. if the stock has a 0.2% weighting within the benchmark then by simply not owning it creates a maximum 0.2% underweight. This limits the potential to outperform and arguably decreases fund management efficiency. By utilising a strategy where the manager has the ability to sell (or short) stocks, positive returns are generated when the stock is bought back at a lower price than it was originally sold at.
An example of how the 130/30 strategy works is as follows. A portfolio is valued at £100 million, the manager identifies a selection of over-priced securities and borrows £30 million to sell those securities short. Once the short sales have been executed in the market he will receive £30 million in sale proceeds which he will then invest into further stocks (or take larger positions in stocks he already holds) creating an overall long position of 130%. The additional 'tool' of shorting stocks enables the manager to remain fully exposed to the underlying market while having the freedom to express a view on a stock that is deemed unattractive. In other words, the manager has the freedom to increase the 0.2% underweight by selling the stock short.
By removing the long-only constraint to allow the flexibility to partially short the portfolio, performance should improve due to the manager's ability to implement their investment views more efficiently. As well as the new concept angle, many firms will market these new funds on their ability to increase performance while fractionally increasing the risk profile of the fund when comparing it to long-only version of the strategy. If this rings true, then there are clear benefits for investors to consider these funds both in isolation and as part of a well diversified portfolio.
At Origen, we anticipate that investor acceptance will increase as this area of the market develops especially with investors who may not be fully comfortable with full long/short strategies.
With interest comes demand so we fully expect to see further launches of funds that can partially short. Partial shorting strategies clearly combine some of the efficiency gains of long/short management together with the market exposure generated from traditional long-only portfolios.
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