Fidelity Jumps on the 130/30 Bandwagon

There's no rush to climb aboard a new fund that leverages and sells short.

The Fidelity brand has been synonymous with sensible mutual fund management ever since the company launched Fidelity Fund in 1930. But when the firm appears to be buying into a fad -- as it does in launching Fidelity 130/30 -- investors are right to be skeptical.

The new fund (symbol FOTTX) takes its name from a particular model of portfolio construction. For every $100 you invest, manager Keith Quinton buys $100 worth of stock and sells short $30 worth of stock. Short selling, a technique for betting that a stock will fall in value, generates temporary cash holdings that Quinton then uses to purchase another $30 worth of stock. Voilà -- $130 worth of long positions and $30 worth of short positions.

Academics drool over the 130/30 concept. By permitting short selling, it allows managers to make money from stocks they think are heading down. But because the fund is effectively 100% long, it still benefits from the market's tendency to deliver gains over the long term.

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For the approach to work as well in practice as it does in theory, you need an ace manager at the helm. Quinton doesn't have a long-term record with Fidelity's retail funds, but so far his results are impressive. He took over Fidelity Tax-Managed Stock (FTXMX) in early 2004, and from then until June 18, the fund returned 10.1% annualized, or an average of four percentage points per year more than Standard & Poor's 500-stock index.

He's also managed Fidelity Disciplined Equity (FDEQX) since late 2006. That fund returned 4.5% annualized during his tenure, or more than three times the S&P 500's returns. Since Fidelity 130/30's inception on April 1, it has returned 6.2%-five percentage points better than the index.

Quinton uses the same approach to stock picking in his new fund as he does with his older, more-traditional funds. He runs a computer model that ranks about 4,000 stocks, incorporating a stock's recent price moves and valuation, as well as Fidelity analysts' "buy" and "sell" ratings and earnings estimates. His goal is to target either cheap stocks that have some catalyst for a rebound or stocks with momentum that could deliver near-term price gains. Quinton buys stocks at the top of the list and shorts those at the bottom.

Fidelity 130/30 is arguably the most compelling fund in a category that has received more than its share of hype. Quinton's is one of the first no-load funds in the 130/30 space, and its 1.23% annual expense ratio is among the lowest.

But before investing in a 130/30 fund, consider a couple of caveats: Unlike most "long-short" or "market-neutral" funds, 130/30 funds are not designed to insulate shareholders against market downturns. All of the 130/30 offerings with a one-year track record have lost money over the past year, and most have lost more than the S&P 500 has.

Also, as with any fund that invests borrowed cash, any missteps will be magnified. Short selling can require a different skill set than simply buying stocks to hold. Moreover, when you buy a stock, you can't lose more than 100% of your investment, but when you sell a stock short, your potential loss is unlimited. Although Quinton is building an impressive record at other Fidelity funds, there's still little history you can use to predict how his shorts will perform.

The strongest advocates of 130/30 funds say this investing technique is much more than a passing trend. "If the world were a perfectly rational place, then by all rights this should put long-only funds out of business," says Kevin Means, manager of Ridgeworth Real Estate 130/30.

Could be. But if he's right, then there's no rush to jump on board.

Elizabeth Leary
Contributing Editor, Kiplinger's Personal Finance
Elizabeth Leary (née Ody) first joined Kiplinger in 2006 as a reporter, and has held various positions on staff and as a contributor in the years since. Her writing has also appeared in Barron's, BloombergBusinessweek, The Washington Post and other outlets.