October 2007

PAST PERFORMANCE: 'Long/short is the new long'

"A 130/30 fund is simply a new packaging of an existing investment process. if a book is bad you should not expect it to improve by redesigning its cover" Niklas Tell / Tell Media Group niklas_tell.jpgJPMorgan Asset Management (JPMAM) recently launched a number of so-called 130/30 funds, where JPM Europe 130/30 is one of them. Given the track-record of JPMAM’s traditional long-only funds run on a behavioural-finance process, this fund will be one to watch. In the introduction to Investing with Anthony Bolton – the anatomy of a stock market phenomenon, by Jonathan Davis one can read: “Fund management remains a competitive, sales-driven business: ‘25% performance and 75% marketing’, as the legendary Warren Buffett once dryly observed”. The question is, do 130/30 funds fall into the larger category of marketing or do they add additional value and therefore fit into the 25% that Buffett labels as “performance”. With the relatively short history of these products only time will tell. The label for this column (Past Performance) should, for this specific column, be understood as looking beyond performance rather than putting historical performance in perspective. It is therefore worth repeating what I wrote in the first column, in the fall of 2005, where the Legg Mason Value fund was profiled: “So, when looking beyond the past performance there are three factors standing out – design, process and people – and it is the combination that makes this fund interesting. It all starts with the design or the set-up of the fund. You can compare it to building a house. If the blueprint does not make sense it does not matter what process you use or who you hire to build it.” Numerous papers have been written and numerous presentations given on the topic of 130/30. The question I ask and hopefully answer here is: can they be a good investment, given the design, process and people? The design, or concept if you will, is straightforward enough and easy to like. Fund managers buy the stocks they like most and sell (short) the ones they think will fall in value. It is not very different from traditional long/short equity hedge funds. The novelty here is of course that it is done within the Ucit framework and that it gives 100% exposure to the equity market (130% long and 30% short gives a 100% net long position). In theory traditional long-only funds can therefore be replaced with these new products, which should provide additional performance. But, even if the blueprint makes sense in theory it is the quality of the underlying investment process that will determine the outcome. We can use the JPM Europe 130/30 Fund as a prime example. The fund was launched on June 25, so we don’t have much to go on, but given the difficult market it was launched into it is off to a fair start. According to Morningstar, the fund was ahead of its peers (Europe Large-Cap Blend Equity) and the index (MSCI Europe) on a one-month basis as of August 28. However, with a beta target of one, and with markets falling in July, the fund is obviously down since launch. Given the track-record of JPMorgan’s traditional long-only funds run on their behavioural finance process it will, however, be very interesting to watch this fund going forward. If the concept of 130/30 is able to live up to its promises this fund should be able to deliver. It is at least run on a solid process. The JPM Europe Equity Fund, which is the traditional long-only version run on the behavioural finance process, does not shine every year, but it has outperformed its peers in both difficult markets (2002) was well as in more speculative markets (2005). In the end a 130/30 fund is simply a new packaging of an existing investment process. If a book is bad you should not expect it to improve by redesigning its cover. The same simple truth holds for these products as well. Whether a good product can be made even better in terms of performance remains to be seen, as fees are higher for these new products. For the JPM Europe 130/30, investors pay 1.5% management fee plus 10% of outperformance above MSCI Europe). If the manager is able to add value on both the long and short end compared to a traditional long-only offering based on the same process the higher fee should be worth it. • Niklas Tell is a partner at Tell Media Group

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