What is a 130-30 strategy? | Investment strategies
Do you want to manage your own retail portfolio using a proven method that institutional investors rely on? This is possible using the 130-30 strategy. What is a 130-30 strategy? Also called a “long-short strategy”, it involves using the leverage of a short position to fund larger gains in a position that should outperform the market. The 130-30 ratio breaks down based on your investment allowance (see below).
Here’s what you need to know about the 130-30 strategy, how it works, and Why It works. This is a strategy that you can deploy in your own wallet with very little experience. Plus, it’s a great way to extrapolate your investments, to make a small amount of money go further, faster.
Breaking down the 130-30 strategy in practice
The 130-30 strategy actually makes more sense when you think of it as the 100-30-30 strategy. It’s about being 100% invested and identifying 30% of your portfolio as possible short opportunities, and 30% of your portfolio as outperformers. The strategy itself involves take advantage of a short position to double outperformers. Here is an example:
Nathan invests $ 10,000 in an all-equity portfolio. Of that $ 10,000, he allocated $ 3,000 to short positions in companies that he says will fall. Then he takes the $ 3,000 from those shorts and reinvests them in stocks that he believes will outperform.
In this example, the 30% uncovered is reinjected into the 100% acquired portfolio (hence 130%). In strategy 130-30, the “130” represents long equity; the “30” represents short equity. This means that it has a leverage of 1.6x, offering greater opportunities for returns.
Investors who use the 130-30 strategy do not choose stocks at random. Instead, they invest in a large index and choose short and long positions within that index to keep it relative. For example, you could be in QQQ: an ETF that tracks the top 100 companies on the Nasdaq. By executing the 130-30 strategy, you would sell 30% of the companies in QQQ and you would be a buyer on the top 30% that you think would outperform.
Why does the 130-30 strategy work?
There’s a reason this strategy is popular with hedge funds and other institutional investors. It works! Well, it works as long as your predictions about the price movement are relatively accurate.
The 1.6x leverage associated with the 130-30 strategy increases the earning power of positions through exposure to short and long positions. When the market goes up, the long position benefits. When it goes down, the short position benefits. The 130-30 strategy is therefore extremely effective. Assuming you are not relying on uncovered options, market movement in either direction has the potential to generate a return on your investment.
There is a level of risk mitigation involved in the 130-30 strategy. In fact, the risk-adjusted returns of this strategy tend to be better than others, including individual stock selection. That said, shorting is still risky, as the potential for loss on open shorts is endless as the price rises. This is an easy strategy to understand, but may require some skill to deploy on your own.
130-30 funds for the inexperienced investor
As is the case with most trading philosophies today, traders have found a way to automate and institutionalize the 130-30 rule in a fund. There are between 130 and 30 funds that deploy the strategy as part of overall execution. That said, these funds often lag behind other funds, unless they are actively managed. The reason? 130-30 strategies are nimble and require frequent entry-exit positions.
If you are looking for an intermediate way to test and try the 130-30 strategy for yourself, consider experimenting with a smaller amount, like $ 1000. It’s easy to find a broad market ETF and select the 30% of positions that you think will outperform and underperform. This is how many investors embark on the 130-30 strategy, redirecting the gains towards the growth of the portfolio.
Advanced opportunities 130-30
While most 130-30 strategies work against general market performance, there are opportunities to use this strategy in specific sectors. For example, you can sell energy stocks and use that leverage to take long positions in health stocks. You can even do this in an industry with companies that you think will decline to the industry average. Whatever the scale, it’s about capitalizing on the gains both ways by understanding the compensating forces.
The 130-30 strategy is best appreciated as a philosophy. There are several important lessons built into this concept:
- Protect yourself by covering your positions
- Use reasonable leverage
- Evaluate companies from a defined perspective
- Be aware of regression to the mean
With these criteria in mind, investors can apply the 130-30 rule in a variety of capacities, provided they follow the framework of the strategy.
Should you follow the 130-30 strategy?
After finding out that this is a proven hedge fund tactic, many investors want to dive right into the 130-30 strategy. Unfortunately, they forget that hedge funds employ expert analysts with unlimited resources to assess and predict market trends! That is, it is difficult to choose stocks and your predictions do not always come to fruition. If you want to explore the 130-30 strategy, start small and learn to deploy this philosophy tactfully.
To better understand the most technical investment strategies, subscribe to the U investment e-letter below. This daily newsletter provides stock market advice, investment trends and education for new and more seasoned investors.
What is a 130-30 strategy? This is about being 100% invested and using a short 30% position to fund a 30% long position, in order to maximize returns. Whether the market goes up or down, you benefit. It’s about hedging your options and picking the right companies to drive ROI.