The 130/30 strategy aims to combine promising stocks with bets that other equities will fall. The name comes from the fund’s structure: 100% equities, with an additional allowance for 30% long and 30% short.
The short cancels out the long, leaving, in effect, a 100% global equity fund.
But Kochar argues that they have a more powerful engine than a conventional equity fund – a Ferrari as opposed to a Volvo.
“The theory is, if you’ve got up to 60% extra gross, you should be able to add more alpha. As long as you control the risk for the whole package, then in theory should be able to add more alpha without adding more material risk.”
The managers focus on companies they expect to have compounded growth that is faster than the market. From a universe of about 4000 stocks, the compounding filter leaves 600-700 names to evaluate.
“We like to buy competitive advantage businesses that enable a higher return on invested capital than an average company in the same industry,” Kochar said. “They’re cashflow-generative and as a tailwind have compounded growth faster than the market.”
As an example, the fund holds Mastercard, one of the two dominant credit card players globally. Kochar explained that Mastercard gets a percentage of every transaction when a consumer uses the card.
“Nobody else can come in [to their space]. You use either Master Card or Visa and they get 95% incremental margins.”
An additional tailwind is that governments want the public to move out of cash and into plastic, he said.
The managers found a short in the same sector – a traditional money transfer company that is losing business to online money transfer firms.
Another example is Microsoft’s move from enterprise computing onto the cloud, which Kochar said accelerated this year. The fund is long Microsoft and the managers see enterprise software companies as a short. “The trends are compounding on both the long and short side,” Kochar said.
“On the short side, we try to find a structurally slow growth business that has leveraged up its balance sheet and competitors are attacking it.”
The team does due diligence by evaluating criteria such as the balance sheet, margin structure and management quality, using ESG factors to identify risks. Only at the end of the assessment do they consider valuation.
“We tend to pay more than the market multiple,” Robson said. “Slightly expensive names but that’s because they are compounding faster than the market.”
Because they buy at high valuations, bond yields going up could impact the portfolio more than the market, he added.
But the managers don’t see an imminent valuation collapse.
“Bond yields are probably ok up to 3.5% [before equities are impacted],” Robson said. “We don’t actually see material inflation right now. Wage inflation hasn’t happened and there is a deflationary trend with technology. So now we don’t think about a valuation collapse in the market.”
In addition to the standard risk of a long-only global equities fund, the strategy also carries the extra risk of getting the short positions wrong.
“We are careful about driving that Ferrari around risky bends and not putting the foot on the accelerator,” Kuchar added.
Columbia Threadneedle’s 130/30 fund, along with several other similar strategies from rival firms, were launched just before the financial crisis due to a change in Ucits legislation that allowed their formation.
As markets tanked in 2008, the funds using the strategy went into a steep plunge. Threadneedle’s product underperformed both the sector and benchmark (see chart below).
Not long after, several 130/30 funds were closed down, including products from SSGA and Allianz.
But Threadneedle’s product survived and eventually outperformed the benchmark and sector when measured on a 10-year basis.