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Investors and traders use hedge strategies to counter market fluctuations. They use a combination of short- and long-term strategies so that the profits earned in the short run will balance the losses accrued in the long-term positions. One such strategy is the 130-30 strategy aimed at achieving capital efficiency. This article will look at the 130-30 strategy in detail and evaluate its pros and cons.
What is a 130-30 strategy?
The 130-30 strategy, also known as the long shirt equity strategy, is a strategy used by institutional investors to manage their capital efficiencies. The 130-30 ratio implies the use of 130% of the starting capital allocated to long positions, and the process of achieving this is through taking in 30% of the starting capital from the shorting stocks. The strategy here is to short the low-performing stocks and buy more long-position shares that are expected to perform well for higher returns.
How does the 130-30 strategy work?
In this strategy, the stocks in the S&P 500 are ranked based on the expected returns from the highest to the lowest. This is done by investment professionals based on the past performance of the stocks. Different criteria are used for this, such as risk-adjusted performances, total returns, and even relative strength. The stocks are ranked from the best performing to the lowest performing based on their performance of 6 months to one year.
From these best-performing stocks, the investment manager now invests 100% of the portfolio value and shorts the low-performing stocks up to 30% of the total profile value. The money received from shorting low-performance stocks is used to buy more good-performing stocks in the long position. As a result, the investors are able to maximise their exposure to the highest-performing stocks.
Advantages of 130-30 strategy
Two major advantages make 130-30 equity investment strategies beneficial for investors. These include:
- Gain profits from low-performing stocks
The investors can make significant profits even from the low-performing stocks by incorporating the 130-30 fund strategy. Investors who only focus on long-term positions might ignore these profits, but investors using this strategy can benefit from the decline. Additionally, this strategy is beneficial for long-term investors who are outperforming because of the compounding benefits they receive over time.
The 130-30 strategy allows investors to earn profits even in the bear market because the short position value will be higher when the stock declines. Long-only investors might have to wait a long time until the market recovers, but investors using this strategy can protect themselves from market fluctuations and even make a profit. Eventually, the strategy helps investors enhance their risk-adjusted returns.
Risks of 130-30 strategy
While the investors can benefit from employing this strategy, there are also certain risks associated with the strategy that must be carefully understood. These include:
- Limited past record
The 130-30 funds were launched in the year 2007, and most of these funds raised were ended due to the economic crisis hit in the year 2008. As a result, these funds have a very limited track record.
- High rates
The investors using the 130-30 short strategy usually use active investment strategies. As a result, they tend to have a higher turnover that leads to higher taxes and even high expense ratios compared with the index mutual funds.
The investors must understand that leverage increases the volatility. This in turn, leads to a higher beta factor and higher risk. It is crucial for investors to consider the volatility levels.
Who should use the 130-30 strategy?
The 130-30 strategy is a beneficial strategy owing to its comparatively risk-free attribute and neutral market exposure. It allows small investors exposure to hedge fund strategies that are otherwise limited because of high risk and net worth. Let us look at the type of investors who should consider the 130-30 strategy:
- Long-only investors
This strategy is suited for long-only investors who want to increase diversification and returns through shorting. They will not have to deal with the risks that come with short, heavy strategies.
- Foundational investors
Investors who are looking to begin investing in large-cap guns can adopt this strategy and benefit from good returns.
- Tax accounts
Lastly, all investors who do not wish to pay taxes on the frequent transactions taking place should not opt for this strategy.
Conclusion
The 130-30 strategy is beneficial for investors looking to make more profits on their long-term investments by shorting the low-performing funds up to 30% of the opening balance. This strategy can help long-term investors to get good returns.
However, different benefits and risks are associated with the strategy that must be considered before adopting it.
FAQs
The 130-30 strategy implies the use of 130% of the starting capital allocated to long positions, and the process of achieving this is through taking in 30% of the starting capital from the shorting stocks.
The funds liquidated from selling the low-performing stocks are used to buy high-performing socks that are expected to perform well in the long run.
The benefits of this strategy include the possibility of gain from low-performance stocks and the chances for earning profits even in bearish markets.
This strategy has a limited past record and involves high expense ratios as well as high taxes. There is also sometimes a high risk due to increased volatility.
The 130-30 strategy is best suited for investors who are looking to make long-term gains and have a diverse portfolio by shorting.