A recent polling of Hong Kong-based institutional investors by Watson Wyatt revealed interest in non-traditional equity strategies, but a rejection of 130/30 and other so-called active extension strategies.

Watson WyattÆs consultants each selected an equity strategy to æpitchÆ clients, who then voted their preferences. Long/short (18% of respondents) and long-term long-only (also 18%) strategies proved popular for alternatives, although traditional passive (23%) and traditional active (23%) maintained their popularity. Support for beta prime strategies (ie using fundamental or wealth-weighted indices) was lukewarm, selected by 13% of respondents.

But active-extension strategy won the hearts of only 5%. Given the hype around 130/30 strategies, this is a surprise. Naomi Denning, director and regional head of investment consulting, suggests however that the hype is the result of many traditional fund management companies jumping on the absolute-return bandwagon, trying to emulate long/short with quantitative strategies that often donÆt add up.

130/30 strategy involves going long 130% and short 30% (there are versions using different degrees of extension, eg 120/20), by first investing 100% into an index, going short 30% of it and using the proceeds from short sales to invest in favoured stocks. These products purport to add some alpha or absolute returns for relatively little volatility, and are usually marketed by traditional fund managers leveraging their quant skills.

ô130/30 strategies are a form of hedge funds without the flexibility,ö Denning says. ôThey give you a beta of one. A long/short fund, on the other hand, can vary its beta exposure. WeÆre not saying there are no decent 130/30 funds out there, but we do think if an investor wants a hedge fund, then get one.ö

She suggests many 130/30 funds are being touted by fund management companies that donÆt have experience in shorting, and whose equity research never covers stocks with short views. Denning believes only a small percentage of firms marketing 130/30 strategies are credible, but these are enjoying asset inflows simply because the demand for absolute-return strategies by investors is so overwhelming, there simply arenÆt enough alternative equity funds out there to meet the need. ôWhy not increase the alpha by going 130/60, for example?ö she wonders.

Anthony Chan, principal investment consultant, adds that investors wanting to use long/short or long-term long/only strategies need to have adequate fund governance, allowing them to foment underlying investment beliefs.

To illustrate this point, Watson Wyatt also surveyed investors about their beliefs about finding alpha and in investment horizons. 86% of respondents say they agree or strongly agree with the statement that æthe ability to short expands a managerÆs opportunity set and ability to generate alphaÆ. This belief naturally leads investors to look at absolute-return strategies. A further 70% agree or strongly agree that æthere is more opportunity to add value in long-term investing than short-term investingÆ, which also coloured their responses about favoured investment strategies.

ChanÆs point is that pension funds and other institutional investors cannot make the right strategic decisions without the proper governance. They may claim to want a long-term strategy but their actual decisions donÆt reflect this conviction, particularly in times of pressure, if they lack the expertise and attention required.