What Are 130/30 Funds?

How to Calculate 130/30 Funds

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130/30 funds are unique investment securities that work quite differently than standard mutual funds. They often invest around a benchmark index, holding both short and long positions on chosen equities.

Find out how 130/30 funds work, along with their risks and benefits.

What Are 130/30 Funds?

130/30 funds are mutual funds that invest in a mix of long and short positions on their stock holdings. A 130/30 fund will be long (or own) stocks worth 130% of the portfolio while shorting 30% of assets in the fund. They may also be called long-short equity funds or short-extension funds. They are considered an alternative asset, or in other words, outside of the "core" asset classes of cash, stocks, and bonds.

How Do You Calculate a 130/30 Fund?

Because they combine both long and short positions, 130/30 funds can increase long exposure to attractive stocks. The fund begins with 100% long positions, then shorts the least attractive holdings 30%, using the proceeds to increase long equity exposure by 30%. This leads to a result of 130% long.

How Do 130/30 Funds Work?

Let’s look at a simple example to better explain the concept of 130/30 funds:

  1. Let's say a fund has $1 million of assets, with which it buys $1 million of securities (100% long).
  2. The fund then borrows $300,000 worth of securities and promptly sells them (30% short).
  3. The proceeds from the short sales are used to buy $300,000 more securities (30% long).
  4. The final result is that the fund has $1.3 million long (130% long) while shorting $300,000 (30% short).
  5. Now we have a 130/30 fund.

A portfolio with both long and short selling may have higher turnover than one that is not mixed. This could lead to extra transaction costs and in some cases may affect taxes as well.

What Are the Benefits of 130/30 Funds?

The 130/30 fund structure may work very well for the active fund manager who wants to add value by picking and choosing single stocks. For instance, the traditional fund manager can choose stocks that they think will increase in value, and they invest 100% of the portfolio in these stock choices. On the other hand, the fund manager of a 130/30 fund also has a net exposure to the market of 100%, but they are able to invest with 160% of the portfolio’s assets.

How do they reach 100% exposure to the market and invest with 160% of the portfolio’s assets? As in the example above, the fund manager decides to buy stocks worth a total of 130% of the fund’s assets, and decides to short stocks worth 30% of the fund's assets. The fund's exposure to the market is 130% positive and 30% negative which nets to 100%. They have made active choices with a gross exposure of 160% of the portfolio (130% long, 30% short).

How Do 130/30 Funds Differ From Others?

The standard equity mutual fund owns the stocks the fund manager thinks will perform better than those of the fund’s benchmark. So for example, the fund manager might buy shares of Microsoft because they think that it will outperform a domestic large-cap equity index, such as the S&P 500. But if this same manager decides that Microsoft has a lousy outlook, they may have to wait it out. They can only sell the stock if they own it at that time.

This is how a standard mutual fund and a 130/30 fund differ. If the manager of a 130/30 wants to get out of a bad investment, they can sell the stock short.

Managers of 130/30 funds can sell the stock without owning the stock. Investors often use this strategy to take advantage of a falling stock price.

So, a manager of a 130/30 fund can choose to buy a stock in order to make money, and also sell stock to make money. Compare this to the traditional fund manager who can only sell a stock to avoid losing money.

Are There Any Limits of 130/30 Funds?

As with any investment, 130/30 funds carry some risk, mainly with short selling and leverage. Note that holding both long and short positions on stocks doesn't guarantee they'll limit the fund's exposure to stock market shifts and other risk factors.

Plus, short selling in itself can rack up more fees to borrow, due to more frequent trades. Short sales also carry the risk of being called at a bad time. If you engage in short sales you may be "called" to sell as part of the deal you signed up for when you bought the option, and the timing is not always in your control.

Key Takeaways

  • 130/30 funds are investments in which the fund holds both long and short positions on chosen stocks.
  • The main benefit of 130/30 funds is the ability for an investor to gain more exposure and therefore more opportunity.
  • 130/30 funds carry risk that comes with any investment, along with the extra risk related to the techniques of leverage and short-selling they use.