A new type of mutual fund may be entering the Canadian market in the near future. This particular type of mutual fund is known as the "130/30 Fund". Let me explain how it gets it’s name:
For every $100 invested into the fund, the fund manger will invest the $100 according to an already established mandate (for example Canadian Large Cap Value). The manager will then also short $30 worth of securities (based on the most over-valued securities in his/her mandate). When you short a security, you are selling a security you don’t already own (you borrow the security from inventory). The hope is that the stock will go down and then you can buy the stock at the lower price and "cover the short position". Think of it as selling high AND THEN buying low – so you make money when the stock goes down. When you open a short position, since you are selling a stock you will receive the money you sold it for from the buyer. In this case of 130/30 funds, the manager will take the proceeds from the short sale and add to his long position.
So 130 represents 130% exposure to the long position and the 30 represents the 30% exposure to the short position.
What does this mean for the investor? I don’t have hard data to post (but will dig some up shortly), but all the claims of the fund companies that risk-adjusted performance should be higher seems unsubstantiated SO FAR. I have seen the performance of these funds in the States and they seem to lag the benchmarks and may be too complex for some investors.
Also it should be noted that holding a short position incurs interest costs, and increased turnover will increase brokerage transaction costs. My guess is that the management fees will also be higher…
The 130/30 fund structure will not only ask managers to pick winning stocks, it will ask them to pick losing stocks (to make money on by shorting them). Add this to two different types of leverage built in to the structure and it would seem that these funds might be worth watching for a while first. The leveraging components increase risk substantially. Make sure to seek out the advice of a professional advisor.
I will post some data and links tomorrow, so stay tuned…