Bloomsbury Financial Planning

So-called '130/30' funds attracted a substantial amount of attention - and investment - last year. They were marketed as a way to give investors enhanced returns through the use of long and short positions.

Fund managers can use 30 per cent of their fund to sell stocks they believe will fall in value, and allocate 130 per cent to stocks that they believe will grow. So, overall, they end up with a 100 per cent long position.

Despite their relatively complicated structure, they proved popular with investors looking for something new. But their performances have, so far, failed to live up to the hype.

Although the funds were not intended as hedging products, they were marketed as having the potential for excess returns.

If the fund manager is good at predicting the rises and falls of stocks, the funds stand to profit from market volatility, when stocks are moving up and down more frequently. They can avoid the worst falls of a depressed market by shorting, while gaining upside through above average exposure to growth.

So the use of shorting is more akin to a long-only equity fund manager taking an underweight position in certain sectors.

However, of the 130/30 funds launched in the UK at the end of 2007, the majority have underperformed their benchmarks. Threadneedle, UBS and F&C's 130/30 funds all posted positive early returns towards the end of 2007, but in the year to date all have underperformed. Some have started to rise again in very recent weeks, but their returns are still negative.

The Resolution Cartesian UK Equity 130/30 is down 11.94 per cent since the end of 2007 (the fund launched on December 21 2007).

"People don't want simple, they want sexy and they want new," explains Jason Butler at Bloomsbury Financial Planning. "And that's the problem. There are no magic short cuts to return."

He believes part of the problem boils down to the pitfalls of active management. "The structure of the funds means that if the managers make a mistake, they can really lose out," he says.

The funds rely heavily on the skills of individual managers. The ability to short stocks requires as much capability as picking out equities that will rise, and 130/30 funds also run the risk of having to pay a premium to purchase the stock they have shorted if it rises in value - so that they can give it back to the lending institution.

Consequently, Bernhard Langer, head of quantitative strategy at Invesco, argues that the Invesco Pan European 130/30 fund should not be viewed as a low-volatility fund that can outperform the market in a downturn. In the past few months, the fund has outperformed the benchmark, but since its launch in October 2007, the fund is down 4.47 per cent. "It still has a long way to go," says Langer.

Mark Dampier of broker Hargreaves Lansdown says of all the 130/30 funds available in the UK, he only recommends the Resolution fund.

"I'm generally cynical about them," he says. "In theory, it sounds good - like a double armoury where you can make money out of long and short positions." However, the theory has not often translated well into practice.

Not only do 130/30 funds tend to come with above average charges, Dampier is not convinced many managers have the requisite skill to run them. He argues that current equity market conditions have shown how very difficult it is to make these sorts of bets on market movements.

If investors want to put money into funds that make use of short positions, Dampier instead recommends they look at the BlackRock Absolute Alpha fund, which he describes as a truly defensive fund doing something new. If markets do well, the fund will underperform but when the markets are poor, the fund excels.

Butler recommends that investors use simple, inexpensive equity investment funds if they want a return that exceeds index-linked gilts - and that they accept the increased risk that comes with these assets.  "There are no short cuts to investing successfully," he says. "Like fitness training or studying for an exam, you need a continual process to achieve real results."

Copyright The Financial Times Limited 2008