130/30 Fund

A 130/30 fund is an investment strategy that involves a hedge fund or mutual fund maintaining a long position in 130% of its portfolio, while also maintaining a short position in 30% of its portfolio.

The long positions are invested in securities that the fund expects to appreciate in value, while the short positions are invested in securities that the fund expects to either decline in value or not appreciate as much as the broader market (and therefore benefit the fund in a relative value type of sense).

The goal of a 130/30 fund is to enhance returns by adding short positions to the traditional long-only portfolio.

This strategy is also known as a long/short strategy.

Key Takeaways – 130/30 Fund

• 130/30 is a type of long/short investment strategy that involves taking both long and short positions in securities, with the goal of outperforming a benchmark index or other benchmark.
• A 130/30 portfolio typically allocates 130% of the portfolio to long positions and 30% to short positions, which allows it to potentially benefit from both rising and falling prices.
• 130/30 is a more aggressive strategy than traditional long-only investing, as it involves taking on additional risk through short selling and active portfolio management. As such, it may not be suitable for all investors.
• Success with a 130/30 strategy depends on the ability to identify both undervalued and overvalued securities, as well as the ability to accurately forecast market movements.
• 130/30 portfolios can be implemented through hedge funds, mutual funds, ETFs, or through individual securities held in a brokerage account. It is important to carefully consider the fees, regulation, and investment objectives of the specific vehicle being used to implement the strategy.

130/30 Fund Basics

A 130/30 fund works by maintaining 130% of its portfolio in long positions (which involves leverage accordingly) and a short position in 30% of its portfolio.

The long positions are invested in securities that the fund expects to appreciate in value. These securities may include stocks, bonds, or other types of securities.

The fund will typically hold these securities for an extended period of time, with the goal of generating returns through capital appreciation.

The short positions, on the other hand, are invested in securities that the fund expects to decline in value or underperform the market.

To initiate a short position, the fund borrows the security from another investor and sells it on the market. If the value of the security declines as expected, the fund can buy it back at a lower price, return it to the borrower, and pocket the difference as profit.

By combining long and short positions in its portfolio, a 130/30 fund aims to enhance returns by adding the potential for profit from short positions to the traditional long-only portfolio. This strategy is also known as a long/short strategy.

It’s worth noting that 130/30 funds are more complex and potentially riskier than traditional long-only funds, as they involve the use of short selling and leverage.

As a result, they may not be suitable for all investors.

Are 130/30 Funds Hedge Funds?

130/30 strategies can be employed by hedge funds, but not usually.

Hedge funds are private investment funds that use a variety of investment strategies and are typically only available to accredited investors.

These funds are known for their flexibility in terms of the types of investments they can hold and the strategies they can employ, and often use leverage, short selling, and other advanced investment strategies and techniques to generate returns.

In contrast, 130/30 funds are mutual funds or exchange-traded funds that are available to retail investors and are regulated by securities laws.

While 130/30 funds do use both long and short positions in the market, they are typically not as flexible or aggressively managed as hedge funds, and are subject to greater regulatory oversight.

It is important to note that there are other types of funds that are similar to 130/30 funds in that they use both long and short positions in the market, such as long/short funds or market-neutral funds.

These types of funds may be more similar to hedge funds in terms of their investment strategies and risk profile, but they are still not considered to be hedge funds.

How Do I Make a 130/30 Portfolio?

A 130/30 portfolio is a type of investment strategy that involves buying long positions in stocks that are believed to have strong potential for appreciation, while also selling short positions in stocks that are believed to be overvalued or likely to decline in value.

Here’s how you can create a 130/30 portfolio:

Identify the stocks you want to include in your portfolio

To do this, you’ll need to conduct thorough research on different companies and sectors to identify potential opportunities for appreciation.

This may involve looking at financial statements, analyzing industry trends, and considering the competitive landscape.

Determine how much you want to allocate to each stock

In a 130/30 portfolio, you’ll typically allocate 130% of your portfolio to long positions and 30% toward short positions.

This means that for every $100 you invest in the portfolio, $130 will be invested in long positions and $30 will be invested in short positions.

Buy the intended long positions

To buy a long position in a stock, you’ll need to purchase shares of the stock through a brokerage account.

Short-sell the intended short positions

To sell a short position in a stock, you’ll need to borrow shares of the stock from another investor and sell them on the market, with the intention of buying them back at a later date when the price has hopefully declined.

Monitor and rebalance your portfolio

As the value of your investments changes, you’ll need to periodically review and adjust your portfolio to ensure that it stays aligned with your investment objectives and risk tolerance.

It’s important to note that short selling is a more advanced investing strategy that carries additional risks, such as the possibility of unlimited losses if the stock price increases rather than decreases.

As such, it’s important to thoroughly understand the mechanics and risks of short selling before implementing a 130/30 portfolio strategy.

Is a 130/30 Fund a Relative Return or Absolute Return Vehicle?

A 130/30 fund is generally considered to be a relative return vehicle, as it seeks to outperform a benchmark index or other benchmark by taking both long and short positions in stocks.

In contrast, an absolute return vehicle is an investment that aims to achieve positive returns regardless of the performance of the overall market.

Absolute return strategies often employ a variety of techniques, such as hedging, leverage, and derivatives, to try to generate returns in both rising and falling markets.

There are a few key reasons why a 130/30 fund might be considered a relative return vehicle:

Benchmark-relative performance

One of the main characteristics of a 130/30 fund is that it seeks to outperform a benchmark index or other benchmark.

This focus on relative performance means that the fund is not necessarily trying to achieve a specific level of absolute return, but rather is trying to outperform a specific reference point.

Long and short positions

A 130/30 fund takes both long and short positions in stocks, which allows it to potentially benefit from both rising and falling prices.

However, the primary goal of these positions is to outperform the benchmark (the traditional goal of a hedge fund), rather than to generate a specific level of absolute return (the standard goal of a mutual fund).

Risk-return tradeoff

Like most investment strategies, a 130/30 fund involves a tradeoff between risk and return.

While the fund may aim to generate attractive returns, it also carries additional risks associated with short selling and active portfolio management.

These risks are generally considered acceptable in the pursuit of outperforming the benchmark, but may not be consistent with the risk tolerance of an absolute return strategy.

Overall, while a 130/30 fund may generate positive absolute returns in certain market environments, its primary focus is on generating returns that outperform a benchmark index or other benchmark.

As such, it is generally considered a relative return vehicle.

Warren Buffett on the LONG-SHORT hedge fund investment strategy

130/30 vs. 120/20 vs. 150/50

130/30, 120/20, and 150/50 are all variations on a type of investment strategy known as a long/short portfolio.

In all of these types of portfolios, as we’ve covered, a trader or investor takes both long positions (betting on the appreciation of a security) and short positions (betting on the decline of a security or underperformance relative to a benchmark).

The numbers in the notation refer to the percentage of the portfolio that is invested in long positions and short positions, respectively.

Of these three variations, 130/30 is the most popular and is also a type of umbrella term for portfolios with 100% net long exposure but with long/short tilts to the them.

There are a few reasons why 130/30 may be more popular than 120/20 or 150/50:

Balance between risk and return

130/30 strikes a certain balance between taking on additional risk through short selling and limiting risk through a more balanced portfolio allocation.

By allocating 130% to long positions and 30% to short positions, a 130/30 portfolio allows for the potential for higher returns while still maintaining a relatively conservative overall risk profile.

Benchmark-relative performance

130/30 portfolios are often designed to outperform a benchmark index or other benchmark, and the 130/30 allocation may provide the appropriate level of tilt to achieve this.

By comparison, a 120/20 or 150/50 portfolio may be more conservative or aggressive allocations.

Market conditions

The popularity of 130/30 may also be influenced by market conditions.

When there are more shorting or relative value opportunities (e.g., one or more sectors might be in bubbles), but the trader/investor is still mandated to keep 100% net long exposure, they might choose to have something closer to a 150/50 allocation (or beyond) to take advantage.

When shorting might add less value to a portfolio, then a 120/20 allocation might make more sense.

Margin restrictions

One additional reason why 130/30 may be more popular than 150/50 is due to margin restrictions imposed by brokerage firms.

In order to sell short, an investor must borrow the shares of stock being sold from another investor, and the lender typically requires the borrower to post collateral in the form of cash or securities.

This collateral is known as margin.

Brokerage firms typically have rules in place that limit the amount of margin an investor can use, as well as the level of risk that can be taken on through the use of margin.

A 130/30 portfolio, with its balance of 130% long positions and 30% short positions, may be more attractive to investors because it allows for the use of margin without requiring a large amount of collateral or exceeding the risk limits imposed by the brokerage firm.

By comparison, a 150/50 portfolio may require a larger amount of margin, which could make it more challenging for investors to implement these strategies due to margin restrictions.

As such, the 130/30 allocation may be more popular in part because it allows for the use of margin without running afoul of these restrictions.

Overall, the choice of a 130/30, 120/20, or 150/50 allocation will depend on the investor’s risk tolerance and investment objectives, as well as the market conditions and the benchmark against which the portfolio is being measured.

130/30 Funds vs. Market-Neutral Long-Short Funds

130/30 funds and market-neutral long-short funds are both types of long/short investment strategies that involve taking both long and short positions in securities.

However, these two types of funds differ in their overall approach to the net allocation, and as a result, they do not necessarily compete with one another.

Here are a few key differences between 130/30 funds and market-neutral long-short funds:

Portfolio construction

130/30 funds typically allocate 130% of the portfolio to long positions and 30% to short positions, with the goal of outperforming a benchmark index or other benchmark.

By contrast, market-neutral long-short funds aim to generate returns that are uncorrelated with the overall market.

As such, they typically seek to maintain an approximately equal balance between long and short positions in order to minimize market risk.

Risk-return profile

130/30 funds are generally considered to be more aggressive than market-neutral long-short funds, as they aim to generate higher returns by taking on additional risk through their higher net market exposure, or beta.

Market-neutral long-short funds, on the other hand, are generally more conservative. They look to minimize market risk and generate returns that are independent of market movements. They are generally alpha creation vehicles.

Benchmark-relative performance

As a result of their different portfolio construction and risk-return profiles, 130/30 funds and market-neutral long-short funds may be benchmarked against different reference points.

130/30 funds may be benchmarked against a market index or other benchmark, while market-neutral long-short funds may be benchmarked against a risk-free benchmark such as cash or Treasury bills.

Overall, while 130/30 funds and market-neutral long-short funds are both long/short investment strategies, they differ in their portfolio construction, risk-return profiles, and benchmark-relative performance, and as such, they do not necessarily compete with one another.

FAQs – 130/30 Fund

Why is shorting important to the 130/30 fund strategy?

Short selling is an important element of the 130/30 investment strategy because it allows the portfolio to potentially benefit from declines in the price of certain securities.

In a 130/30 portfolio, 30% of the portfolio is allocated to short positions, which means that the portfolio is betting on the decline of a specific security or group of securities.

There are a few key reasons why short selling may be important to the 130/30 strategy:

1. Potential for higher returns: By taking both long and short positions in the market, a 130/30 portfolio may be able to generate higher returns than a long-only portfolio. This is because the short positions may offset some of the losses from the long positions, potentially resulting in a more stable or even positive overall return.
2. Diversification: Short selling can also help to diversify the risk in a 130/30 portfolio by allowing the portfolio to potentially benefit from declines in the price of certain securities. This can be especially useful in a market where certain sectors or individual securities may be overvalued or prone to volatility.
3. Market timing: Short selling can also be used as a market timing tool, allowing a 130/30 portfolio to potentially profit from short-term declines in the market or in specific securities. This can be especially useful in a market where it is difficult to identify long-term opportunities for appreciation.

In short, short selling is an important element of the 130/30 strategy because it allows the portfolio to potentially benefit from declines in the price of certain securities, diversify risk, and potentially profit from market timing.

Are 130/30 funds hedge funds or mutual funds and ETFs?

Both hedge funds and mutual funds/ETFs can be structured as 130/30 portfolios.

A 130/30 portfolio is a type of long/short investment strategy that involves taking both long and short positions in securities, with the goal of outperforming a benchmark index or other benchmark.

Hedge funds are privately offered investment vehicles that are typically more flexible and less regulated than mutual funds/ETFs.

Hedge funds may use a variety of investment strategies, including long/short strategies like 130/30, and they may also employ leverage and derivatives in order to achieve their investment objectives.

Mutual funds and ETFs, on the other hand, are publicly offered investment vehicles that are required to disclose their holdings and are subject to more stringent regulation than hedge funds.

Mutual funds and ETFs can also use long/short strategies, including 130/30, but they may be more limited in their use of leverage and derivatives.

So, both hedge funds and mutual funds/ETFs can be structured as 130/30 portfolios, but they differ in their regulation, flexibility, and the types of strategies they can employ.

Conclusion – 130/30 Fund

130/30 funds and market-neutral long-short funds are both long/short investment strategies.

However, they differ in their portfolio construction, risk-return profiles, and benchmark-relative performance.

As a result, these two strategies do not necessarily compete with one another.

Short selling is an important element of the 130/30 strategy because it allows the portfolio to potentially benefit from declines in the price of certain securities, diversify risk, and potentially profit from market timing.

Finally, while some 130/30 funds may be structured as hedge funds or mutual funds and ETFs, others may be structured as private investments only available to qualified investors.