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Mutual Funds

It Sounds Like a Good Idea, but ...

Managers of a new kind of fund struggle to make the concept actually work.

The mutual fund industry loves to adapt the hard-to-explain strategies of Wall Street for funds aimed at you and me. But sometimes these concepts can be so challenging that the real question is whether the funds are worth the hype. In most cases, probably not.

The latest example is the 130/30 fund. Many of these funds seek to produce a few percentage points per year of extra return over a full market cycle (a multiyear period that includes a rising market and a falling market) without taking on more risk than a fund's benchmark index.

That's hard to turn down, so the assets of 130/30 mutual funds have gone from zero to $3.4 billion in two years. There are at least 20 such funds, and more are coming. Nearly all levy sales charges.

The distinguishing feature of 130/30 funds is their idiosyncratic use of short selling. For every $1,000 you invest, you get a "long" (regular stock ownership) position of $1,300 and a short position -- a bet on falling share prices -- of $300.


The net result is a bet that 130% of the portfolio will go up in value and 30% will go down. So 130/30s should act much like the stocks they focus on -- such as large-company growth stocks or small-company value stocks -- but with managers' picks generating extra returns from stocks heading in both directions. (The 130/30 category also includes 120/20 and 140/40 funds, which leverage and sell short in different proportions but follow the same principles as 130/30 funds.)

Obviously, the approach can backfire. Using leverage magnifies losses as well as gains. Success is just as contingent on manager expertise as it is with any other fund. "It really depends on manager skill and executing the strategy in a rational manner," says Morningstar analyst Marta Norton.

Managers croon about the strategy's advantages, paramount being the freedom to pick winners and losers at the same time. "Being long-only is a constraint, and now people are coming around to that," says Ric Thomas, who manages Accessor Small to Mid Cap (symbol ACSIX).

Short selling lets managers put more of the information already at their disposal to work. "This creates a process to recognize the value of stocks that would otherwise go in the junk bin," says Scott Bondurant, manager of UBS US Equity Alpha (BEAAX).


There's little in the way of a sniff test to tell whether the funds can live up to their lofty aspirations. The only open-end fund offered without a load is Thomas's Accessor fund, which transitioned to a 120/20 structure in October and was down 4% to December 10. Only a handful of 130/30 funds are more than a year old, and their one-year returns, which range from a 3% loss to an 18% gain to December 10, aren't especially illuminating.

Variation on a theme. Old Mutual Claymore Long-Short (OLA) is a closed-end fund, which means it trades like a stock and you pay regular brokerage commissions. It uses a 120/20 structure and has the longest record of the 130/30s.

Old Mutual has returned an annualized 6% on its assets since its August 2005 inception, trailing the 12% annualized return of Standard & Poor's 500-stock index, with slightly more volatility. On a positive note, at its mid-December share price of a bit more than $16, the fund was trading at a 14% discount to the value of its underlying assets.

So ignore the hype and wait until there are results -- and more no-load options -- before jumping in. As Lipper analyst Jeff Tjornehoj stresses, "Don't buy a fund just because it sounds interesting."