130/30 Funds Structures

2011-07-28T20:57:00.008+01:00

130/30 Funds Structures

130/30 funds are viewed as a way for investors to take advantage of an active manager’s stock picking expertise known as enhanced strategies. But should investors invest in 130/30 funds and what are the risks of investing in such enhanced- strategies.

In order to understand the concept of a 130/30 strategy, it is essential to compare against a traditional equity mutual fund. In a traditional mutual fund, the manager takes a long position (buy) in the stock(s) that he believes will outperform the index. Conversely, having owned the above stock(s), the manager may decide to sell if it transpires that the stocks are not good investments. Thus in the first example the manager purchases the stock to make a positive return whist in the later the manager sells the stock(s) in this portfolio to avoid a negative return.

The second instance highlights the difference for a manager following a 130/30 strategy. Both managers have the ability to take long positions, however only the 130/30 manager has the ability to sell stocks they do not already own in order to take advantage of an underperforming stock. Thus the 130/30 manager can make money by either going long or short positions in the portfolio.

In a 130/30 structure, the manager will be long (buy) stocks worth 130% of the new asset value of the fund as well as being short (selling) stocks worth 30% of the new asset value.

Illustration of a 130/30 Fund

1. A fund with £10m worth of assets (net asset value) and buys £10m worth of stocks (100% long).

2. The manager believes some stocks are over valued and due to fall so borrows £3m worth of stocks and sells those stocks (30% short

3. With the proceeds from (2) above, the managers buys an additional £3m worth of stocks (30% long).

4. The fund thus has £13m worth of stocks long (130%) whilst shorting £3m (30% short)

5. The fund thus has a gross exposure of 160% of Net Asset Value.

NB: the above excludes transaction and borrowing costs.

Fig 1: 130/30 structures

Gross Exposure

In Figure 1, the traditional long only fund has a gross expose of 100% of net asset value by virtue of the absence of leverage. In contrast, the 130/30 fund has a gross exposure of 160% (130+30) of NAV by virtue of the re-investment of the proceeds of the 30% short sale.

Both funds have a net exposure of 100% of NAV however, the 130/30 fund carries higher risk. As we can see the net exposure is always equal to the long only position in all cases however, the enhanced strategy will carry a higher risk than a long only fund.

Returns and Benchmark

By using his stock selection expertise, the long only manager would expect the long only fund to outperform the index but in reality, this may not always possible, after transaction costs and fees. The 130/30 fund by contract will exhibit a different return profile to the long only fund given its enhanced leverage notwithstanding that fact that both portfolios have the same beta-one net exposure to the market. During a bull market returns may be enhanced but there may be greater losses during a bear market. For this reason, the benchmark for a 130/30 fund will not be the market index or the corresponding long-short strategy index but will be a hybrid or proprietary index.

Challenges Facing Pension Fund Trustees

2009-07-13T19:10:00.009+01:00

PRESENTATION
April 2009

A. Introduction

Changes in The Industry in Recent Years

Pension Reform published 11 June 2003
- Solvent companies to buy-out deficits in wind-up
- Funding obligation became compulsory for sponsors
Pension Act 2004
- Power to Trustees to collect on liabilities
(e.g. Tesco transfer £500m property contingent rights to Trustees)
- Power to Pensions Regulator to ensure best practice

Shift from Defined Benefit (DB) to Defined Contribution (DC)
- Cost of risk-free pension, beyond the means of sponsors
- The Pension Protection Scheme (2006)
- A centralised compulsory Insurance Scheme as a result of Mergers, takeovers, etc

The Pensions Act 2008
- Employers: New duties to (automatic enrolement/3% min contribution)
- Regulator: New objectives to maximise compliance
Current Financial Crisis
- Increase pressure on funding and risk of default/insolvency
- Emphasis on the management of risk using LDI and ALM

B. Challenges Facing Trustees

The Current Challenges for Trustees

Falling in the Value of Pension Fund Assets
Breach of Covenants by Sponsors
Solvency Risk affecting DB funding
Meeting Investment Objectives
Fear of Personal Liability
Longevity Risk

Challenges Facing Trustees

Fall in the Value of Pension Fund Assets
- Drawdown in equity market (worldwide) 60-80% decline over 12 months and credit write downs.
- Aggregate shortfall breach £253bn in March 2009 (FT Apr 09)
Breach of Covenants affecting funding
- Increase in the cost of debt of Companies.
- Falling revenues and drying up on credit markets
- Management time on managing risk and protecting cash flows
Company Solvency Risk affecting DB funding
- Fall in company revenues and assets from write-down
- Decrease in solvency ratio and call on Pension Protection Fund
- 95% Solvency Ratio for UK Pension Funds (Hewitt Associates)
Meeting Investment Objectives
- Use of Liability Driven Investments or Asset Liability Management techniques
- Increase use of Alternative Assets
Fear of Personal Liability Affecting Membership
- Increase use of professionals for investment advice
- Need for education and guidance on risk management
- The extent of hedge fund exposure to toxic assets (FoF)
Longevity Risk
- Decrease in mortality (no. of over 65s double in 10 yrs to 2007)
- Fall in membership
- Funding future pensions

C. Future Challenges

Legislation and regulations if crisis persists
Increased responsibility/training and education
New investment products, e.g. CTAs/derivatives/options/innovative strategies/overlays
New risk management techniques
Sharing of pension risk.

Thinking Finance

130/30 Funds Structures

Challenges Facing Pension Fund Trustees