Written by Justin Kuepper. Updated by TraderHQ Staff.
Many hedge funds use long-short strategies in order to profit in both rising and falling equity markets. By maintaining both short and long positions, investors can reduce market risk within their portfolios and increase risk-adjusted returns. Short position gains in falling markets help offset losses in long positions and vice-versa, while a tendency to hold overvalued shorts and undervalued longs creates alpha.
In this article, we’ll take a look at the so-called 130/30 strategy, which is designed to create an optimal long-short portfolio and realize many of these benefits.
What Is the 130/30 Strategy?
The 130/30 strategy involves short-selling stocks up to 30% of a portfolio’s total value that the trader believes will underperform the market and then using the proceeds to take a long position in stocks the trader believes will outperform the market. For example, a trader might invest 100% of a portfolio in the S&P 500, short-sell the bottom ranked stocks, and reinvest the 30% for a 130% long exposure.
Let’s take a look at a quick example of this process:
- A fund raises $1 million and buys $1 million worth of securities, making it a basic run-of-the-mill 100% long-only fund.
- The fund borrows $300,000 worth of securities and sells them with the agreement to repurchase later, giving it a 30% short position.
- The $300,000 in proceeds from the short sale are used to buy $300,000 worth of additional long securities, making the fund 130% long.
- The end result is a fund that has $1.3 million (130%) in long securities and $300,000 (30%) in short securities, making it a 130/30 fund.
Since many 130/30 traders invest in large-cap equities or indexes, the strategy can be considered a core asset rather than an alternative asset in most cases. The difference between traditional hedge fund and 130/30 strategies is that the latter is managed against specific benchmark indexes that underlie the portfolio rather than speculating on specific securities as many hedge funds try to do.
According to some studies, the 130/30 structure captures about 90% of the benefits of leverage, while eliminating many of the risks. Those skeptical of 130/30 funds call the idea more of a marketing gimmick than a proven strategy, pointing out that many traditional long-only funds have outperformed their 130/30 counterparts over time.
Benefits of the 130/30 Strategy
The major benefit of the 130/30 strategy is the ability to profit from the bottom quartile of equities. Whereas a long-only investor would simply ignore these stocks, traders using the 130/30 strategy have the flexibility to profit from their decline. Even modestly outperforming long-only investors can produce substantial compounding benefits for traders using the 130/30 strategy over time.
A second major benefit is being able to profit during bear markets, since short positions gain value as an equity declines. While long-only investors must wait on the sidelines for a market recovery, those using the 130/30 strategy can hedge their portfolio against a market decline and even profit in some cases. These dynamics can improve overall risk-adjusted returns over time.
After all, Wall Street’s prime brokerage business has been largely powered by the growth of hedge funds, partly due to their profitability using short positions. Short selling and the leverage it employs may be a double-edged sword, but competent managers employing tried-and-true strategies may be able to generate consistent alpha over time, just as many hedge funds have managed to do.
Who Should Use the 130/30 Strategy?
Many traders can benefit from the 130/30 strategy given its unique neutral market exposure and relatively risk-free nature compared to traditional short selling. In some ways, the 130/30 strategy provides Main Street investors with a way to access strategies that have been the hallmark of hedge funds—which have been limited to high net worth individuals due to their riskier nature.
Some market participants that could benefit include:
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Long-Only Investors. Investors seeking to increase diversification and return potential by expanding into short selling without the traditional risks associated with short-only or short-heavy strategies.
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Foundational Investors. Investors looking to build exposure to a diverse number of large-cap U.S. companies may benefit from exploring the 130/30 strategy as an alternative to simply purchasing low-fee funds.
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Tax Advantaged Accounts. Investors that don’t want to incur current year taxes on frequent trading—typical for 130/30 strategies—may want to consider avoiding the strategy to save money.
Risks and Other Considerations
The 130/30 approach gained significant popularity in the mid-2000s, but the 2008 financial crisis made short selling enormously difficult and expensive. Since then, the number of 130/30 funds has thinned out significantly. Traders and investors should carefully consider their risks before making any investment decisions.
Some key risks and considerations include:
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Limited Track Record. Many 130/30 funds have a relatively limited track record, and several that launched in the mid-2000s ended up folding due to the 2008 economic crisis.
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Efficient Market Hypothesis. Many long-only investors believe that minimizing fees represents the only way to generate long-term alpha, proven by the fact that most fund managers underperform the major indexes.
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Leverage Increases Risk. The use of leverage increases volatility in most cases, which leads to a higher beta-coefficient and greater risk. These levels of volatility are important for investors to consider.
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Higher Fees & Turnover. Most 130/30 funds use active investment strategies, which means that they tend to have higher turnover (bad for tax purposes) and greater expense ratios than index mutual funds.
The Bottom Line
130/30 funds have had a rough start since they became popular, but the survivors provide traders and investors with a unique opportunity. By taking both long and short positions, the funds act similar to hedge funds in their ability to generate leveraged returns and protect against downside risk, but choosing the right manager remains more important than ever.
Frequently Asked Questions
What’s the difference between 130/30 and a traditional hedge fund?
A 130/30 fund is benchmarked against a specific index (like the S&P 500) and aims to outperform it, while maintaining similar sector exposures. Traditional hedge funds often have no benchmark, can use much higher leverage, and may take concentrated bets on specific securities or themes. The 130/30 structure is generally considered lower risk than typical hedge fund strategies.
Can individual investors implement a 130/30 strategy themselves?
Technically yes, but it’s challenging. You need a margin account with short-selling capabilities, must manage the complexity of maintaining proper ratios, and face borrowing costs for shorted shares. Most individual investors are better served by investing in a 130/30 mutual fund or ETF that handles this complexity professionally.
Why would I short 30% specifically—why not more or less?
The 30% short allocation represents a balance between capturing the benefits of short selling while limiting the additional risk and complexity. Higher short allocations increase leverage and potential drawdowns during short squeezes or bear market rallies. The 130/30 ratio has become somewhat standardized, though variations like 120/20 or 140/40 also exist.