Alpha - September 2007 - (Page 68)

13030 Only a handful of the new 130/30 funds have three-year track records. As the product evolves, some funds will no doubt fall by the wayside category, or turn an equity product into an absolutereturn product,” he says. “Our research shows it can improve the information ratio of certain managers by 20 percent or more and raise returns by approximately 50 to 150 basis points – net of financing cost and fees – by converting the manager's research more efficiently into alpha, assuming he or she has the ability to generate alpha in the first place." Finding Shares to Borrow The big impact on hedge funds might come from increased competition to borrow shares to sell short, which could push up stock-borrowing fees charged by prime brokers. But Credit Suisse’s Calderone is one prime broker who insists there would be no shortage of borrowable shares, because 130/30 products create more supply by investing their short proceeds in more long positions (hence the 130 on the long side in their generic name). “That normal rehypothecation through the prime broker creates supply,” he says. “It's somewhat self-supporting." Prime brokers aren’t the only ones who doubt there will be shortages of shares to borrow. “If you consider some of the main benchmarks in the US – such as the S&P 500 and the Russell 1000 – there’s plenty of liquidity in terms of stocks to borrow. It’s about 99 percent in S&P and 98 percent for the Russell 1000,” says Will Cazalet, director of long/short strategies at AXA Rosenberg. “Securities lending is a $4 trillion market for equities. That ought to give people a lot of comfort in terms of availability.” Will Cazalet AXA Rosenberg is a quant AXA Rosenberg manager that launched a global strategy 130/30 fund last September. The firm has subsequently launched a series of regional funds and is in the process of launching a pure US 130/30 fund, using the Russell 1000 benchmark. Cazalet concedes, however, that as in any market, some individual stocks will be difficult to borrow. “That’s where a diversified strategy really comes into play. If we find a stock is difficult, impossible or too expensive to borrow, we can swap it with another name that has similar characteristics.” Moreover, Thomas at State Street says that prime broker fees are now coming down. “They initially were charging fees that weren’t economical,” he says, “but I think when they realized the potential volume of business from 130/30 strategies, they were much more willing to negotiate. There has also been a bit of competition on the prime brokerage side from some of the slightly smaller firms, which is putting pressure on the biggest operations. I’m not sure how much further prices will come down, but we’re happy with where they are right now.” Of course, the desire of any hedge funds to get into the 130/30 market depends on high volume, given the lower fees, and not everyone believes the new hybrids will accumulate $1 trillion in assets. After all, as Calderone points out, even though assets are clearly growing, some long-only managers are philosophically opposed to the product. And only a handful of the new funds have three-year track records. As the product evolves, some funds will no doubt fall by the wayside. "There will likely be a shakeout if people jump in who don't have the right experience or ability to control their risk,” Calderone says. “If someone's new to shorting, they might not realize you need to monitor this every single day.” Indeed, given the recent market volatility, those new to shorting and its impact on risk management are up against a steep learning curve. “You need to have experience in shorting stocks from a trading and operational standpoint – dealing with prime brokers, being able to integrate the cost of shorts – and know the effect short positions can have on the portfolio,” says Cazalet at AXA Rosenberg. “That has been even more important over the last few weeks, when the market has been in a state of turmoil.” But Shaffer argues that as new funds are launched – increasing the number of products, benchmarks and track records in the market – the assets in 130/30 strategies will mount even more quickly. It wouldn’t require a huge reallocation of pension fund assets to have a major impact. Jason Segal, co-head of the 130/30 team at Citigroup, judges that "if just 10 percent of US pension fund allocations in US core equities were switched into 130/30 products, this would be more than 10 times the size of global assets under management in 130/30 funds now." Whether they are in or out of the market right now, hedge fund managers might do well to stay abreast of the game. ● 6 • Alpha Sponsored Report • September 2007

Table of Contents Feed for the Digital Edition of Alpha - September 2007

Contents Letter from the Editor Longs & Shorts Pension Corner: Keeping the Faith The Good Guys: Going Public Interview: Barry Bausano - A Delicate Balance Cover Story: Cruel, Cruel Summer Profile: Phil Cooper - Alternative Flight Plan Strategies: Marshall Wace - TOPS in Its Field Profile: Fortis Investments - Banking on Alternatives Research Center: Top Equity Trading Firms Alpha Bytes: Desktop Duel Unhedged: Commentary - The Taxman Cometh

Alpha - September 2007

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