FUND managers are an innovative lot. Just when one might think that one has seen it all in terms of the types and permutations of mutual funds, enter a fresh breed of funds that purports to deliver more than just a straight exposure to an asset class.
The "new" fund type on the block is one that effectively takes short positions on stocks, even though short selling is traditionally out-of-bounds in the mutual fund market. The funds, dubbed 130-30, have gained a toehold among institutional investors in Europe and the US, and are winding their way through the retail markets there. Such funds could hit US$1 trillion in value in three years, according to projections.
In Singapore so far, there are less than a handful of such funds but more are in the pipeline. After all, the funds purport to deliver "alpha", manager-speak for any excess returns above benchmarks. Against the current backdrop of uncertainty and sharp volatility, any manager that manages to deliver alpha is surely doing a good job and is worth his weight in fees.
The key challenge, as always, is the ability to deliver alpha consistently. 130-30 uses derivatives to effectively create an overall position that is 130 per cent long and 30 per cent short.
In theory, the ability to profit in a rising market with astute stock-picking on the long side, and still profit in a falling or volatile market from stocks that are expected to weaken should deliver the best of both worlds, or nearly so. There are, however, caveats. The first is that a 130-30 fund is not a hedge fund and the volatility of the structure could equal or even exceed that of a traditional fund.
The second is that a greater onus is placed on a fund manager's skill as he is expected to pick stocks both on the short and long sides. And third, while such a structure is often marketed along the lines of expected outperformance, the fund could actually fare worse as short bets gone awry could magnify losses.
To be sure, 130-30 funds will in due course make their presence felt in Singapore. This is because most funds marketed here are structured under Europe's UCITS III framework, which enables them to use derivatives to effect an efficient portfolio and achieve an absolute return. So far, funds that have utilised the full capabilities allowed under a UCITS III passport are in the minority. But this is set to change as competition hots up for assets. Such a product could help to distinguish one manager's offerings from the rest.
Innovation is surely a good thing in fund management. Derivatives, in particular, have allowed institutions to fine-tune products to suit various shades of risk appetites, even as their efficacy in risk mitigation is increasingly under scrutiny. But the big question is suitability for individual investors, and structures like 130-30 are no exception.
Ultimately, the most sensible portfolio is a simple long-only allocation to stocks and bonds according to how much risk one can tolerate, and enough time in the market to reap the benefits.
