Meet the new beast on Wall Street: The 130/30 fund. Most mutual funds buy stocks that their managers expect will rise in value -- "going long," in market parlance. But 130/30 funds also short stocks, betting that they'll fall in price as part of their strategy to profit from the market.
As fellow Fool Amanda Kish discussed in a recent article on long-short funds, it's not new for funds to short stocks, but the 130/30 structure is becoming more popular. As the name suggests, the fund invests 130% of its assets in long positions, and 30% in short ones.
Here's how Todd Trubey explained it in a recent Morningstar article:
Let's say such a fund has $1 million in investor assets. It buys a $1 million portfolio of stocks long and establishes a $300,000 short portfolio. So when one shorts, one receives cash for the just-sold shares--in this example, $300,000. The 130/30 manager will then reinvest that cash, thus adding a 30% long stake to the existing 100% long stake and the 30% short stake. And voila, a portfolio is 130% long and 30% short.
Got it? Trubey also offered some reasons why various financial pros are excited about the offering. For example, "... it allows the asset manager to invest $160 for every $100 an investor devotes to the fund."
Don't lose perspective
You shouldn't get too excited about these funds. The borrowed money that fund managers are investing along with your contributions could get you a much bigger bang for your buck. But that effect cuts both ways, and if the managers' bets go sour, you could also lose a lot more. Like any fund, a 130/30 will only be as good as the managers running it. And as we've been pointing out for more than a decade here in Fooldom, the vast majority of managed mutual funds fail to outperform simple index funds.
That's no less true in the 130/30 realm. The ING 130/30 Fundamental Research Fund
Another drawback to these 130/30 funds is their tax inefficiency. They often feature lots of active trading, which generates commission costs and short-term gains. The latter get taxed as ordinary income, rather than enjoying the discount afforded to long-term capital gains. (If you have to invest in such a fund, consider parking it in a tax-advantaged account.)
While these funds are certainly interesting, they're not worth rushing into. When you consider their risks, you may well conclude that you'll do just as well or better in your regular, old-fashioned investments.
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