In the never-ending battle for your investment dollars, there will always be new products and new pitches from Wall Street. After all, who wants yesterday's boring old mutual funds when there are newer, shinier products like leveraged exchange-traded funds and hedge funds to tempt you today? And while some new products will catch on and become fairly popular among the masses, others will have a short shelf life or have trouble reaching critical mass. These are the investments you would be better off avoiding in the first place.
The long and short of it
Although long-short mutual funds have been around in one form or another for many years now, a new breed surfaced more recently that grabbed a lot of attention as they broke onto the scene -- the 130/30 fund. In such a fund, a portfolio manager shorts 30% of the total portfolio assets in stocks he or she believes are overvalued and uses the money from those short sales to invest in more long positions, amounting to 130% of fund assets. Thus, the moniker "130/30" refers to the fund's long and short positions, respectively.
If you believe in the concept of active management, the idea is a sound one. After all, if you have a portfolio manager or management team doing the hard equity research work to find undervalued companies, wouldn't they be equally versed in which companies are overvalued? Why not capitalize on that knowledge by allowing them to short those very companies so you can profit on both ends of the spectrum?
Unfortunately, 130/30 funds haven't exactly been living up to expectations. While some bold market watchers expected inflows to 130/30 funds to reach $1 trillion by now, those estimates have proven grossly optimistic. Since the initial boom back in 2006 and 2007, many 130/30 and other like-minded funds have closed, while other shops have delayed or canceled launches of new products. Now there are just a handful of funds and institutional accounts that use this strategy, with combined assets estimated at around $30 billion, according to The Wall Street Journal. Adding to the clouded future for the funds, RidgeWorth Investments recently announced it would be closing three 130/30 funds by the end of May. The field is definitely getting narrower for these types of investments.
High hurdles
Of course, one of the reasons many 130/30 funds have stumbled is the same reason many plain-vanilla actively managed mutual funds have stumbled: A fund is only as good as its manager. It's been proven time and time again that the majority of active funds can't beat the market over the long run. 130/30 funds face the same hurdle, except now you are adding leverage to the equation, magnifying any potential slip-ups. If your average fund manager can't beat the market, then the average leveraged, long-short, or 130/30 fund will probably fall short by an even wider margin.
And then there is the question of expenses. Like most new-to-the-scene investment ideas, 130/30 funds are generally more expensive than the average mutual fund. According to Morningstar, the average large-cap blend fund sports an annual expense ratio of 1.28%, where the average 130/30 fund charges 1.64%, while the average long-short fund (including more than just 130/30 funds) has a shocking 2.10% price tag. Compare that toa low-cost exchange-traded fund like SPDR S&P 500 ETF at just 0.09%! That price differential is just more ground the portfolio manager has to overcome to even match, much less exceed, market returns.
Think twice, buy once
Ultimately what investors need to realize is that, like so many investing ideas, the concept behind 130/30 funds is sound, but in practice, there is a lot left to be desired. I think anyone considering a 130/30 or long-short fund should seriously reconsider whether such a fund is really appropriate for them. If the current trend continues, there may not be many 130/30 funds left in another year or two.
However, if you're still jonesing for some downside protection with a fund that can short stocks, stick to a fund with a proven long-term track record. There aren't many in this category, but Hussman Strategic Growth (HSGFX) is one of them. Manager John Hussman has been pessimistic on the U.S. economy for years and fully hedges his investment portfolio. However, he has still found some attractive opportunities in the health care sector, which has lagged the broader market in recent years. Hussman looks for companies that fit within his framework of favorable valuation and favorable market action, or advancing trends across multiple market measures.
The fund's investment strategy leads to its owning a diverse set of stocks, including large- and mid-cap health care names AstraZeneca
The path that 130/30 funds have taken is a fine example of what can happen to trendy, of-the-moment investments. Investors should never jump on the bandwagon of any new product, no matter what its claims are. The truth is for most folks, the old tried-and-true approaches and products will still work best -- that's why they are still around when so many competitors have faded away.
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