What is a 130-30 Strategy?
Want to manage your own retail portfolio using a tried-and-true method that institutional investors rely on? It’s possible using the 130-30 strategy. What is a 130-30 strategy? Also called a “long-short strategy,” it involves using leverage from a short position to fund stronger gains in a position that’s expected to outperform the market. The ratio of 130-30 breaks down based on your investment allocation (see below).
Here’s what you need to know about the 130-30 strategy, how it works and why it works. It’s a strategy you can deploy in your own portfolio with very little experience. Moreover, it’s a great way to extrapolate your investments, to make a small amount of money go further, quicker.
Breaking Down the 130-30 Strategy in Practice
The 130-30 strategy actually makes more sense when you think about it as the 100-30-30 strategy. It involves being 100% invested, and identifying 30% of your portfolio as possible short opportunities, and another 30% of your portfolio as outperformers. The strategy itself involves leveraging a short position to double down on the outperformers. Here’s an example:
Nathan Invests $10,000 in an all-equity portfolio. Of that $10,000, he’s allocated $3,000 into short positions in companies he thinks will fall. Then, he takes the $3,000 from those shorts and reinvests it into securities he thinks will outperform.
In this example, the 30% short leverages back into the 100% vested portfolio (hence, 130%). In the 130-30 strategy, the “130” represents the long equity; the “30” represents short equity. This means it has 1.6x leverage, offering greater opportunities for returns.
Investors employing the 130-30 strategy aren’t picking stocks at random. Instead, they’re investing in a broad index and picking short and long positions within that index to keep it relative. For example, you might be in QQQ: an ETF that tracks the top 100 companies in the Nasdaq. In executing the 130-30 strategy, you’d short 30% of the companies in QQQ and go long on the top 30% you believe will 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 so long as your predictions about price movement are relatively accurate.
The 1.6x leverage associated with the 130-30 strategy increases the earning power of positions via exposure to both 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 an extremely efficient one as a result. Assuming you’re not relying on uncovered options, market movement in either direction has the potential to generate ROI.
There’s a level of risk mitigation involved in the 130-30 strategy. In fact, risk-adjusted returns on this strategy tend to be better than others, including individual stock picking. That said, shorting is still risky, since the potential for loss on uncovered shorts is infinite as the price rises. It’s an easy strategy to understand, but can take 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 130-30 funds out there that deploy the strategy as part of general execution. That said, these funds often lag behind other funds unless they’re actively managed. The reason? 130-30 strategies are agile and require frequent enter-exit from positions.
If you’re looking for an intermediate way to test and try the 130-30 strategy for yourself, consider experimenting with a smaller sum, like $1,000. It’s easy to find a broad market ETF fund and select the 30% of positions you believe will over-and under-perform. This is how many investors get started with the 130-30 strategy, funneling gains back into portfolio growth.
Advanced 130-30 Opportunities
While most 130-30 strategies play out against broad-market performance, there are opportunities to use this strategy in specific sectors. For example, you might short energy stocks and use that leverage to take out long positions in healthcare stocks. You can even do this within a sector with companies you believe will regress to the mean for that industry. No matter the scale, it’s about capitalizing on the gains in both directions by understanding offsetting forces.
The 130-30 strategy is best appreciated as a philosophy. There are several important lessons built right into this concept:
- Protect yourself by covering your positions
- Utilize a reasonable amount of leverage
- Evaluate companies within a defined lens
- Be aware of regression to the mean
With these criteria in mind, investors can apply the 130-30 rule in a variety of capacities, so long as they follow the framework of the strategy.
Should You Follow the 130-30 Strategy?
After they discover that it’s a tried-and-true 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 at their disposal to evaluate and predict market trends! This is to say that picking stocks is difficult, and your predictions might not always pan out. If you want to explore the 130-30 strategy, start small and learn how to deploy this philosophy tactfully.
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What is a 130-30 strategy? It’s about being 100% invested and using a 30% short position to fund a 30% long position, to maximize returns. Whether the market goes up or down, you benefit. It’s all a matter of covering your options and picking the right companies to propel ROI.