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INVESTING: New Wall St. 'product' far from a sure thing

February 25, 2008

Financial securities often are called intangibles, since they lack physical attributes and thus are not easily described. That is why investment firms like to package investments into what they call "products."

Products lend themselves to more concise descriptions of what the investor is buying, and therefore a product is easier to sell. Mutual funds are probably the best example of an investment product.

Now, products have entered the realm of hedge funds in the form of 130/30 funds. The numbers refer to the weightings of the long and short portfolios. That is, a 130/30 fund invests 30 percent of its assets in a short portfolio and 130 percent of its assets in a long portfolio. The "hook" is that an investor ends up with a portfolio that is 100 percent "net long", as the 30 percent shortsell position theoretically offsets the 130 percent invested in stocks.

Pension plans are pouring money into 130/30 funds, and it won't be long until individual investors are pitched these products. There already are a handful of mutual funds structured as 130/30 funds.

There is plenty of sales sizzle here. The numerical symmetry of 130/30 gives a potential investor the feeling he is getting something unique. In addition, these products can provide an entry for the public into "alternative investments"-in other words, hedge funds for the masses.

The investment firms will make the usual arguments for hedge funds. The ability to make money in all kinds of market environments, steady returns (low volatility), a non-correlation with the stock market, and the ability to buy "good" stocks and sell short "bad" stocks. Marketers also will promote that these funds hold the promise of higher long-term returns. The fact that, overall, the hedge fund industry has failed to deliver on these ideals will have no bearing on 130/30 fund rollouts.

Investors should be careful with these products. First of all, while 130/30 funds will be touted as similar to owning a portfolio 100 percent invested in stocks, they actually allow the asset manager to invest $160 for every $100 an investor devotes to the fund. This is accomplished by borrowing money to leverage the portfolio. Also, a 130/30 arrangement isn't going to prevent poor investment management. And, of course, the fees are higher in these products.

As with any investment product, what counts are the quality of the management and the performance of the individual securities that make up the overall investment. This is something buyers of collateralized debt obligations and collateralized loan obligations-investment products in their own right-are finding out in a painful way now.

While it has been too short of a period to judge, the few 130/30 mutual funds that have launched over the past year have underperformed the S&P 500 index.

Investors with an inclination to do their own research can bypass investment products and assemble their own personal fund at much less cost and perhaps enjoy better performance.



Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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