One of the main types of institutional investors is the mutual fund. In the last five years, a new type of fund has been created called 130/30 active extension. A mutual fund (a.k.a. long only) can only buy securities. The 130/30 fund can short securities in the same manner as a hedge fund. However, leverage is restricted to 30% of the portfolio value. There are other funds that have more or less leverage and are known as 150/50, 140/40 or 120/20 funds.
The proceeds from the short sales can be re-invested as additional investments. The fund still has overall 100% exposure to the markets. This allows investment management firms to capitalize on all their research. If a firm's analysts and portfolio managers cover a stock and determine that it's price will go down, then it can act on that knowledge by shorting the stock. In a mutual fund, they would sell the position or not buy it.
130/30 were created by mutual fund complexes as a reaction to the growth of hedge funds after the technology bubble. At that time, absolute return vehicles were growing rapidly and mutual funds had lost the trust of the investors. Hedge funds were increasingly taking away the best talent from mutual funds and this was seen as another way to combat the brain drain. 130/30 funds would command higher fees than long only funds and contribute to their bottom line.
An issue would be the availability of stocks to short. Do the mutual fund managers know how to short stocks from an operational point of view? Do they have the relationships with Prime Brokers' stock loan desks that hedge fund managers do? One does not call a stock loan representative out of the blue and ask to borrow securities.
Later on, we will compare the strategies and results of mutual funds, 130/30 funds, long/short hedge funds and equity market neutral hedge funds.
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