130 / 30

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130 / 30 the new black?

• Tommy Adams
• Steven Beveridge

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Agenda

1. What are they trying to achieve?
2. How did they arrive?
3. 130 / 30 and UCITS III
4. Can anyone do it?
5. Is the market ready for it?

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• Part one
• What are they trying to achieve?

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Whats in a name?

• Aliases
• short extension, leveraged alpha, active
  extension, extended equity, 1X0 / X0
• Not a strategy in itself
• Not an absolute return approach
• Stepping stone to a hedge fund

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What does 130 / 30 mean?

• Traditional long fund - 100
• Borrows 30 of stock and sells short
• Reinvests 30 premium in best long ideas
• 100 net long
• 160 gross exposure

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Greater freedom and greater conviction

• Allows managers greater flexibility to express
  their views and add alpha in two ways
• Least admired stocks can be expressed as 5 short
  rather 0.4 underweight
• More capital directed towards best ideas

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Increasing the alpha opportunity

• Alpha generation still comes from stock picking
  ability - both long and short
• 130 / 30 removes some constraints of long only
• But still relatively constrained in comparison to
  say most long short hedge funds
• net 100 long
• extension part is market neutral
• gross 160
• So relatively benign way of increasing alpha
  opportunity

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Equity product spectrum
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Why 130 / 30?

• 110 / 10
• 120 / 20
• 130 / 30 optimal risk reward payoff
• 140 / 40
• 150 / 50 max leverage allowed under UCITS

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Part two How did they arrive?
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US origins

• First short extension fund launched 2002
• But only joined by a handful prior to 2006
• US investors gt 50bn now
• Mainly institutional and family office interest
• Some 15 of US institutional investors invest in
  130 / 30 funds (Source Vodia Group)

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Growing number of products

• Currently most still run as segregated mandates
  ..
• .. But rapid rise in mutual fund offerings

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How have they performed so far?

• So far so good ..
• .. but not enough funds have been around long
  enough ..

Source eVestment Alliance
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Driving forces behind 130 / 30

• Institutional led demand for higher conviction
  strategies and alpha generation
• Fusion of traditional and alternative investment
  techniques hedge-lite
• Hedge fund providers as well as traditional
  long-only managers see opportunities
• Differentiation by geography and asset class
• Facilitated by UCITS III regulations

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Part three 130 / 30 and UCITS III
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UCITS III

• 130 / 30 is a specialist high alpha fund
• Offshore or onshore
• Daily pricing
• Investor eligibility
• Institutions private banks, Fund of Funds,
  Discretionary Managers, Portfolio Bonds (Hong
  Kong)
• Available to specialist retail market in UK and
  can be pass-ported cross-border
• Dont have to be qualified investor
• No large minimum investment levels

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UCITS III

• Gearing
• Gearing through swaps - gross exposure is limited
  to 200 of Fund NAV (130 / 30 160 - so in
  theory could have 150 / 50)
• Shorting
• No physical shorting allowed within UCITS III
  Fund (Irish Financial Regulator has changed
  stance!)
• ..but synthetic shorting can be achieved by
  Portfolio Swap / Contract for Difference held by
  the Fund

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Typical swap terms

• Governed by ISDA between Fund and Swap
  Counterparty
• Fund pays LIBOR X bps for long exposure
• Fund receives LIBOR Y bps for short exposure
• Initial margin with variation margin popular
• Cross margining of positions within swap to
  minimise collateral requirements
• Monthly and forced resets (important for UCITS
  counterparty exposure limits)
• Can trade away with any (approved) broker

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Assets held by Fund

• All assets held with custodian
• Valuation and fund prices by Fund Administrator
• Basket of stocks within one OTC swap (long and
  short exposure)
• Swap will reflect M2M value of underlying
  securities less financing costs

The Fund (UCITS III)
Cash
Portfolio Swap Long and short exposure
Physical Stocks Long only
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Example portfolio 1

• 100 physical stocks plus swap

• Separate reporting to be consolidated
• Minimises financing costs but incurs custody fees
• Daily risk management / UCITS III compliance
  monitoring more onerous, with separate part of
  portfolio
• Stamp duty trading costs (for long UK stocks)

30 long
100 long
30 short
Physical stocks
Swap wrapper
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Example portfolio 2

• Allows for cash reserve for any margin
  requirement
• Vary age physical stock held (dependent on
  factors such as markets)
• Allows Fund to take advantage of dividend
  enhancement opportunities for long positions on
  swap and transaction cost efficiencies for UK
  positions

• In practice 80 physical stocks plus swap

50 long
80 long
30 short
Physical stocks
Swap wrapper
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Example portfolio 3

• 100 cash plus swap

• Operational simplicity
• Consolidated reporting facilitated
• Simpler risk management
• Efficient UCITS III compliance monitoring
• Swap financing on total balances
• Counterparty exposure may be greater (monthly
  resets help to manage this) limit 10

130 long
30 short
Swap wrapper
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Risk management

• Sophisticated user of derivatives the OTC
  derivative is used for investment purposes
• VaR analysis used to monitor swap risk exposure
  e.g.
• Absolute VaR calculated daily (lt5 of Fund value,
  99 confidence interval, holding period 1 day)
• Relative VaR (relative to benchmark index)
  checked quarterly
• Risk Management Process (RMP) document lodged and
  approved with Financial Regulator

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Part fourCan anyone do it?
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Can anyone do it?

• Increased Alpha potential with similar risk
• Conviction led portfolio
• Shorting skills are paramount
• Many have tried and failed

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Alternative Investment Techniques

• Opportunity for hedge fund managers to widen
  distribution
• Cartesian Capital UK Boutique
• Previous hedge fund experience
• Recognised shorting credentials

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A different skill-set

• Buy signals may not necessarily be used as sell
  signals

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Cartesian 130 / 30

• Launched November 2007 Dublin UCITS
• Number of holdings 75
• circa 55 long and 20 short
• Maximum Long per individual stock 10
• Maximum Short per individual stock 5
• Aim to keep exposure at 160 although flexibility
  to be in the range 100 160
• Min / Max net long exposure 90-110
• Aim to keep net long exposure at 100

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Future Developments at Resolution

• Ideas in the pipeline
• Managers in other asset classes with shorting
  experience
• Rigorous product development challenge process
• Roll out later in 2008

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Part fiveIs the market ready for it?
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Is the market ready for it?

• Developed in the US for Institutional demand
• Growing awareness in UK
• Pension Funds investing from equity allocation
• Retail demand for Alpha.

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Considerations for Retail Market

• Market Research
• IFAs
• Consumers
• Level of understanding
• Support
• TCF obligations

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What did we find out?

• Clearly a new concept for many
• Alpha angle has generated interest
• Keen to find out more
• Consumers Yes as part of a balanced portfolio
• Key emphasis on education

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The new black?

• Institutional interest proven
• Retail wait and see approach
• Is it the new black?

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Wouldnt go that far but

• We see it as part of purple future

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Disclosure

• This presentation is for professional clients and
  investment professionals only and should not be
  relied upon by retail clients.
• This document does not constitute or form part of
  any offer or solicitation to issue, sell,
  subscribe or purchase any investment, nor shall
  it or the fact of its distribution form the basis
  of, or be relied on in connection with, any
  contract for the same.
• Cartesian Capital TM and the Cartesian Capital
  logo are trademarks owned by Resolution
  Investment Services Ltd and are used under
  licence by Resolution Fund Managers Ltd.
• Cartesian UK Equity 130/30 fund is a sub fund of
  Resolution International Funds plc, an open ended
  company investment company incorporated in
  Ireland.
• The value of the investments and any income from
  them can fall as well as rise and is therefore
  not guaranteed. Exchange rate movements may cause
  the value of overseas investments to fluctuate.
• Issued and approved by Resolution Investment
  Services Limited authorised and regulated by the
  Financial Services Authority. Registered in
  Scotland No. SC101825. Registered office
  Resolution House, 50 Bothwell Street, Glasgow, G2
  6HR, Tel [phone].