Administration January 1, 2008

DBSummit07: 120/20 and 130/30 Strategies

As defined benefit plan sponsors look for ways to increase funding and manage risk, 120/20 and 130/30 funds are increasingly being touted as useful investment strategies.

Reported by

Rebecca Moore

align=”center”> Audio Recordings of the 2007 DB Summit Are Available Here

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Basically, the strategy is to invest 100% in a long position then sell short either 20% or 30% and invest the proceeds of the sell in the long position (see DB in Flux: And Then Some , The Long and the Short of It ). John Keefe, Contributing Editor for PLANSPONSOR magazine and panel moderator at PLANSPONSOR’s DBSummit in Washington, D.C., said these strategies hold the promise of producing alpha for large cap U.S. equities, but warned that the strategies do come with risk and its manager skill, not mechanics, that is important for strategy success. Keefe also pointed out 120/20 and 130/30 strategies have higher transaction costs, greater custodial complexity, and higher fees, but firms are renegotiating rates and introducing new fee schedules based on performance.

Sponsors can evaluate return potential for funds using these strategies by looking at the same style benchmarks as long-only strategies, assuming a 30% greater alpha, offered panel member David Honold, Analyst, Portfolio Manager at Turner Investment Partners. Sponsors can also look to their peers and ask what other companies are seeing with their 120/20 or 130/30 strategies, he added. Honold noted that Morningstar and Lipper, among others, are developing benchmarks for these funds (see S&P Unveils 130/30 Index Product , Credit Suisse, AlphaSimplex Team Up on 130/30 Index ).

Risks Magnified

If sponsors decide the use of these strategies is right for their plans, they should realize that the risks from these long/short strategies are magnified, so investment managers should be sector-neutral and conduct extensive research when selecting stocks, according to Honold.

John Power, Senior VP of U.S. Equities at Pyramis Global Advisors, added that sponsors should ask why the manager shorts. If it is to leverage on long positions and sponsors have the resources, they can use the strategy more cheaply on their own. A manager should short to generate more alpha and reduce risk, according to Power. In addition, sponsors need to make sure a manager has the resources to generate a variety of “short” ideas, Power said.

Managers can use a variety of methods in long/short strategies, and sponsors should look at all method results when making a decision, Power added.

Panel member Philip Vasan, Managing Director, Credit Suisse, told audience members the manager selected should offer best execution and best financing on the short side, and sponsors should work with asset managers they know to have a great degree of buying power.