The 130-30 strategy, often called a long/short equity strategy, refers to an investing methodology used by institutional investors. This investing strategy makes use of shorting stocks and putting the cash from shorting those shares to work buying and holding the best-ranked stocks for a designated period. It uses financial leverage by shorting poor-performing stocks and, with the cash received by shorting those stocks, purchasing shares that are expected to have high returns. From the best ranking stocks, the manager would invest 100% of the portfolio's value and short sell the bottom ranking stocks, up to 30% of the portfolio's value. Short selling is much riskier than investing in long positions in securities; thus, in a 130-30 investment strategy, a manager will put more emphasis on long positions than short positions.
What Is the 130-30 Strategy?
The 130-30 strategy, often called a long/short equity strategy, refers to an investing methodology used by institutional investors. A 130-30 designation implies using a ratio of 130% of starting capital allocated to long positions and accomplishing this by taking in 30% of the starting capital from shorting stocks.
The strategy is employed in a fund for capital efficiency. It uses financial leverage by shorting poor-performing stocks and, with the cash received by shorting those stocks, purchasing shares that are expected to have high returns. Often, investors will mimic an index such as the S&P 500 when choosing stocks for this strategy.
Understanding the 130-30 Strategy
To engage in a 130-30 strategy, an investment manager might rank the stocks used in the S&P 500 from best to worse on expected return, as signaled by past performance. A manager will use a number of data sources and rules for ranking individual stocks. Typically, stocks are ranked according to some set selection criteria (for example, total returns, risk-adjusted performance, or relative strength) over a designated look-back period of six months or one year. The stocks are then ranked best to worst.
From the best ranking stocks, the manager would invest 100% of the portfolio's value and short sell the bottom ranking stocks, up to 30% of the portfolio's value. The cash earned from the short sales would be reinvested into top-ranking stocks, allowing for greater exposure to the higher-ranking stocks.
130-30 Strategy and Shorting Stocks
The 130-30 strategy incorporates short sales as a significant part of its activity. Shorting a stock entails borrowing securities from another party, most often a broker, and agreeing to pay an interest rate as a fee. A negative position is subsequently recorded in the investor’s account. The investor then sells the newly acquired securities on the open market at the current price and receives the cash for the trade. The investor waits for the securities to depreciate and then re-purchases them at a lower price. At this point, the investor returns the purchased securities to the broker. In a reverse activity from first buying and then selling securities, shorting still allows the investor to profit.
Short selling is much riskier than investing in long positions in securities; thus, in a 130-30 investment strategy, a manager will put more emphasis on long positions than short positions. Short-selling puts an investor in a position of unlimited risk and a capped reward. For example, if an investor shorts a stock trading at $30, the most they can gain is $30 (minus fees), while the most they can lose is infinite since the stock can technically increase in price forever.
Hedge funds and mutual fund firms have begun offering investment vehicles in the way of private equity funds, mutual funds, or even exchange-traded funds that follow variations of the 130-30 strategy. In general, these instruments have lower volatility than benchmark indexes but often fail to achieve greater total returns.
100% Equities Strategy
A 100% equities strategy is a strategy commonly adopted by pooled funds, such as a mutual fund, that allocates all investable cash solely to stocks. read more
A contra market is one that tends to move against the trend of the broad market or has a low or negative correlation to the broader market. read more
An index fund is a pooled investment vehicle that passively seeks to replicate the returns of some market indexes. read more
Indexing may be a statistical measure for tracking economic data, a methodology for grouping a specific market segment, or an investment management strategy for passive investments. read more
Long-short equity is an investing strategy of taking long positions in stocks that are expected to appreciate and short positions in stocks that are expected to decline. read more
A long/short fund is a type of mutual fund that takes long and short positions in investments typically from a specific market segment. read more
An open market is an economic system with no barriers to free market activity. Barriers to free market activity include tariffs, taxes, licensing requirements or subsidies. read more