130 / 30 – the new black?

Tommy Adams

Steven Beveridge

Agenda

1. What are they trying to achieve?

2. How did they arrive?

3. 130 / 30 and UCITS III

4. Can anyone do it?

5. Is the market ready for it?

Part one:

What are they trying to achieve?

What’s in a name?

• Aliases:

– short extension, leveraged alpha, active

extension, extended equity, 1X0 / X0

• Not a strategy in itself

• Not an absolute return approach

• Stepping stone to a hedge fund

What does 130 / 30 mean?

• Traditional long fund - £100

• Borrows £30 of stock and sells ‘short’

• Reinvests £30 premium in best ‘long’ ideas

• 100% net long

• 160% gross exposure

TraditionalLong Only Fund

100% market exposure

0% market exposure

Long portfolio

Long Exposure

Short Exposure

Greater freedom and greater conviction

• Allows managers greater

flexibility to express their

views and add alpha in

two ways:

– Least admired stocks

can be expressed as

5% short rather 0.4%

underweight

– More capital directed

towards ‘best ideas’

Underweight

Overweight

Least favoured stocks

Best ideas

Traditional long only

130 / 30

Increasing the alpha opportunity

• Alpha generation still comes from stock picking

ability - both long and short

• 130 / 30 removes some constraints of long only

• But still relatively constrained in comparison to say

most long short hedge funds:

– net 100% long

– extension part is market neutral

– gross 160%

• So relatively benign way of increasing alpha

opportunity

Equity product spectrum

Enhanced Index

Style specific

Index / ETF

Focussed Active extension

Increasing tracking error

Relative return

Absolute return

Low net HF

Equity market neutral

Long bias HF

beta alpha

Why 130 / 30?

• 110 / 10

• 120 / 20

• 130 / 30 – optimal risk reward payoff

• 140 / 40

• 150 / 50 – max leverage allowed under UCITS

Part two:

How did they arrive?

US origins

• First short extension fund launched 2002

• But only joined by a handful prior to 2006

• US investors > $50bn now

• Mainly institutional and family office interest

• Some 15% of US institutional investors invest in

130 / 30 funds (Source: Vodia Group)

Growing number of products

• Currently most still run as

segregated mandates ..

• .. But rapid rise in mutual

fund offerings

How have they performed so far?

• So far so good ..

• .. but not enough funds

have been around long

enough ..

Source: eVestment Alliance

Driving forces behind 130 / 30

• Institutional led demand for higher conviction

strategies and alpha generation

• Fusion of traditional and alternative investment

techniques – ‘hedge-lite’

• Hedge fund providers as well as traditional long-

only managers see opportunities

• Differentiation by geography and asset class

• Facilitated by UCITS III regulations

Part three:

130 / 30 and UCITS III

UCITS III

• 130 / 30 is a specialist high alpha fund

• Offshore or onshore

• Daily pricing

• Investor eligibility

– Institutions – private banks, Fund of Funds, Discretionary

Managers, Portfolio Bonds (Hong Kong)

– Available to ‘specialist’ retail market in UK and can be

‘pass-ported’ cross-border

– Don’t have to be qualified investor

– No large minimum investment levels

UCITS III

• Gearing

– Gearing through swaps - gross exposure is limited

to 200% of Fund NAV (130 / 30 = 160% - so in theory

could have 150 / 50)

• Shorting

– No physical shorting allowed within UCITS III Fund –

(Irish Financial Regulator has changed stance!)

– ..but synthetic shorting can be achieved by Portfolio

Swap / Contract for Difference held by the Fund

Typical swap terms

• Governed by ISDA between Fund and Swap Counterparty

• Fund pays ‘LIBOR + X’ bps for long exposure

• Fund receives ‘LIBOR – Y’ bps for short exposure

• Initial margin with variation margin popular

• Cross margining of positions within swap to minimise collateral requirements

• Monthly and forced resets (important for UCITS counterparty exposure limits)

• Can ‘trade away’ with any (approved) broker

• All assets held with custodian

• Valuation and fund prices

by Fund Administrator

• Basket of stocks within

one OTC swap (long and

short exposure)

• Swap will reflect M2M value

of underlying securities

less financing costs

Assets held by Fund

The Fund (UCITS III)

Cash

Portfolio Swap

Long and short exposure

Physical Stocks

Long only

Example portfolio 1

100% physical stocks plus swap

• Separate reporting to be consolidated

• Minimises financing costs but incurs custody fees

• Daily risk management / UCITS III compliance

monitoring more onerous, with separate part of

portfolio

• Stamp duty trading costs (for long UK stocks)100%long

30% long

30% short

Physical stocks

Swap ‘wrapper’

Example portfolio 2

In practice: 80% physical stocks plus swap• Allows for cash reserve for any margin requirement

• Vary %age physical stock held (dependent on

factors such as markets)

• Allows Fund to take advantage of dividend

enhancement opportunities for long positions on

swap and transaction cost efficiencies for UK

positions

80%long

50% long

30% short

Physical stocks

Swap ‘wrapper’

Example portfolio 3

100% cash plus swap • Operational simplicity

• Consolidated reporting facilitated

• Simpler risk management

• Efficient UCITS III compliance monitoring

• Swap financing on total balances

• Counterparty exposure may be greater (monthly resets help to

manage this) – limit 10%

130% long

30% short

Swap ‘wrapper’

Risk management

• Sophisticated user of derivatives: the OTC derivative is

used for investment purposes

• VaR analysis used to monitor swap risk exposure e.g.:

– Absolute VaR calculated daily (<5% of Fund value,

99% confidence interval, holding period 1 day)

– Relative VaR (relative to benchmark index) checked

quarterly

• Risk Management Process (RMP) document lodged

and approved with Financial Regulator

Part four:

Can anyone do it?

Can anyone do it?

• Increased Alpha potential with similar risk

• Conviction led portfolio

• Shorting skills are paramount

• Many have tried and failed

Alternative Investment Techniques

• Opportunity for hedge fund managers to widen

distribution

• Cartesian Capital UK Boutique

• Previous hedge fund experience

• Recognised shorting credentials

A different skill-set

• Buy signals may not

necessarily be used

as sell signals

Good

Growth

Market position

Free cash flow

Financial strength

Restructuring / recovery

Corporate activity

Bad

Aggressive accounting e.g. revenue recognition; policy changes; off balance sheet liabilities

Low earnings quality e.g. divergence of declared profit; cash generated; tax paid; recurring exceptionals; unsustainable margins

Financial weakness e.g. on and off balance sheet debt; large working capital requirements; overdependence on short term facilities; pensions; leases

Long position Short position

Cartesian 130 / 30

Launched November 2007 – Dublin UCITS

Number of holdings: ~75

– circa 55 long and 20 short

Maximum Long per individual stock 10%

Maximum Short per individual stock 5%

Aim to keep exposure at 160% although flexibility to

be in the range 100 – 160%

Min / Max net long exposure 90%-110%

– Aim to keep net long exposure at 100%

Future Developments at Resolution

• Ideas in the pipeline

• Managers in other asset classes with shorting experience

• Rigorous product development challenge process

• Roll out later in 2008

Part five:

Is the market ready for it?

Is the market ready for it?

• Developed in the US for Institutional demand

• Growing awareness in UK

• Pension Funds investing from equity allocation

• Retail demand for Alpha.

Considerations for Retail Market

• Market Research

– IFAs

– Consumers

• Level of understanding

• Support

• TCF obligations

What did we find out?

• Clearly a new concept for many

• Alpha angle has generated interest

• Keen to find out more

• Consumers – Yes as part of a balanced portfolio

• Key emphasis on education

The new black?

• Institutional interest proven

• Retail wait and see approach

• Is it the new black?

Wouldn’t go that far but…

• We see it as part of ‘purple’ future

Disclosure

This presentation is for professional clients and investment professionals only and should not be relied upon by retail clients.

This document does not constitute or form part of any offer or solicitation to issue, sell, subscribe or purchase any investment, nor

shall it or the fact of its distribution form the basis of, or be relied on in connection with, any contract for the same.

Cartesian Capital TM and the Cartesian Capital logo are trademarks owned by Resolution Investment Services Ltd and are

used under licence by Resolution Fund Managers Ltd.

Cartesian UK Equity 130/30 fund is a sub fund of Resolution International Funds plc, an open ended company investment

company incorporated in Ireland.

The value of the investments and any income from them can fall as well as rise and is therefore not guaranteed. Exchange

rate movements may cause the value of overseas investments to fluctuate.

Issued and approved by Resolution Investment Services Limited authorised and regulated by the Financial Services

Authority. Registered in Scotland No. SC101825. Registered office: Resolution House, 50 Bothwell Street, Glasgow,

G2 6HR, Tel 0141 222 8000.