Invesco Quantitative Strategies 13030 Strategies Past

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InvescoQuantitative Strategies130/30
StrategiesPast Future
The information presented is for informational
purposes only and should not be used for
investment purposes. All material presented is
compiled from sources believed to be reliable and
current, but accuracy cannot be guaranteed. This
is not to be construed as an offer to buy or sell
any financial instruments and should not be
relied upon as the sole factor in an investment
making decision. As with all investments there
are inherent risks. Please obtain and review all
financial material carefully before investing.
Past performance is not indicative or future
results. This does not constitute a
recommendation of the suitability of any
investment strategy for a particular investor.
The opinions expressed herein are based on
current market conditions and are subject to
change without notice.
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130/30 Basics

• Many names for same thing 130/30, Short
  Extension, Extended Alpha, Directional
  Long/Short, Active Extension
• 1X0 / X0
• Long 1X0 in stock
• Short X0 in stock
• Goal Potential for greater returns by taking
  more meaningful active underweights
• The problem

Median weight 8 bps
Source Standard Poors, Invesco
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Long-Only Constraint Can Hinder Alpha Transfer
An illustration of active position weights for a
representative long-only portfolio

• Highly diversified portfolio of 120 stocks
• The portfolio lacks symmetry
• The ability to generate alpha is focused mostly
  on stocks the manager expects to outperform

For illustrative purposes only.
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Improved Linearity In Portfolio Construction
Illustration of active position weights for a a
representative 130/30 portfolio

• Underweighting the least attractive stocks with
  the same degree of conviction as those stocks
  overweighted
• Highly diversified portfolio of about 400 stocks
• Long (overweighted and underweighted positions)
• Short positions

For illustrative purposes only.
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Advantages of Relaxing the Long-Only Constraint

• Higher excess return potential
• If investment insights are accurate, expect
  excess returns to increase by up to 50 over a
  comparable long-only strategy1
• Higher potential tradeoff of excess return to
  excess risk
• Improvement due to more active weights (bets) on
  greater number of positions with the freedom to
  be long or short
• Capital is fully invested and used more
  efficiently
• Allocation of active bets is proportional to
  expected return
• Short positions allow more efficient allocation
  of risk
• Harnesses manager stock selection and portfolio
  construction skills
• Greater flexibility to capture investment
  insights without
• being entirely constrained by the benchmark

1 Returns are net of estimated costs of trading
but gross of management fees and leverage costs
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Mechanics Overview

• 130 long and 30 short for 100 of capital
• Reg T limit 21 maximum leverage
• 150 / 50 maximum under Reg T using Standard Prime
  Brokerage
• Standard vs Enhanced Prime Brokerage
• Costs
• Financing cost Must pay interest on borrowed
  capital (Fed Funds x)
• Short proceeds Receive interest on short sale
  proceeds less haircut (Fed Funds - y)
• Total cost x y
• Stock borrow considerations
• Prime Broker as traditional source
• Hard-to- / unable-to-borrow raises cost / lowers
  returns
• Cost subject to change over time
• Pre-borrow, firm locates, time limit

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Provider Types Benefits
Quant
Fundamental
Traditional Asset Manager Hedge Fund
Cons Pros Pros Cons Shorting Expertise/Infrastruct
ure Fees Access to borrow Liquidity/Transparency S
trategies with shorting sole business Investment
horizon/Incentives
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Risks Complexities130 / 30 vs Long-only

• Leverage
• Long and short investments exceed investors
  capital
• Market risk is not leveraged
• Short Selling
• Downside is theoretically limitless
• Expertise in identifying shorts
• Availability to Borrow (rebate risk)
• Liquidity (short squeeze)
• UBTI
• Income earned by a tax-exempt entity that does
  not result from tax-exempt activities, such as
  earnings on assets financed with borrowed funds
• Prime Broker Relationship
• SEC oversight but not a fiduciary
• Counterparty Risk

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The Early Days

• Early providers
• Gray beards launched 130/30 in 2000 (DuPont
  Capital - June, 2000)
• Mostly quantitative equity managers
• Per eVestment Alliance only eight offerings by
  year-end 2004 64 by year-end 2007
• Interest from consultant / plan sponsor side
• Opportunity to capture better returns
• Able to maintain relationship with trusted
  long-only provider
• Remain exposed to the market
• Dipping your toe in the alternatives pool
• Use of strategies
• Long-only vs. alternatives bucket
• Standard vs. 130/30 benchmark
• Strategy benchmarks
• Large cap (SP 500 Russell 1000) dominates1
• 6 of the 8 (75) of those launched by 12/31/04
• 44 of the 64 (69) of those launched by 12/31/07
• Asset growth projections
• AUM growth2, 1Q07 3Q07 77
• AUM growth3, 3Q07 1Q08 22

1 eVestment Alliance, 11/21/08 2 Pensions
Investments 3 Pensions Investments 4 Pensions
Endowments 21, Institutional demand for 130/30,
Gordon J. Latter and John Haugh, Merrill Lynch, 8
January 2008
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The View From Last Year

• Small but not insignificant early adoption rate
• Strong interest in strategy from both investors
  managers

Source www.allaboutalpha.com
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Results 130/30 StrategiesLong-Term Vs
Short-Term

• Long-term is relative
• 130/30 Managers slightly behind benchmark over
  last year
• Results better over long-term

Period Ending 9/30/08 Period Ending 9/30/07 1
Yr 3 Yrs 2 Yrs Median, all managers -22.01 0.88 14
.41 SP 500 -21.98 0.22 13.58 Difference -0.03 0.6
6 0.83 of Observations 68 12 16
Source eVestment Alliance
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Results Long-Only StrategiesLong-Term Vs
Short-Term

• More crowded space
• Near equal to 130/30 over three years
• Better performance over last year
• Contrary to expectations

Period Ending 9/30/08 Period Ending 9/30/07 1
Yr 3 Yrs 2 Yrs Median, all managers -20.55 0.89 13
.59 SP 500 -21.98 0.22 13.58 Difference 1.43 0.67
0.01 of Observations 348 339 383
Source eVestment Alliance
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Current State of 130/30 Market

• AUM recent growth
• AUM1 as of 9/30/08 54 bil
• AUM2 as of 9/30/07 54 bil
• Market-adjusted inflows, last 12 months 15 bil
  (28)
• Institutional investors attitudes
• 70 say investment in 130/30 will remain
  unchanged in 2009 from current levels3
• 9 intend to add 130/30 to their portfoios4
• Satisfaction rating5 3.8 / 5 for 130/30

1 Pensions Investments 2 Pensions
Investments 3 FUNDfire, 11/12/08, based on a
recent survey from Morningstar and Barrons. 4
JPMorgan Asset Management 5 Lehman Brothers,
Alternative Equity Survey Results, August 2008
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Current State of 130/30 MarketTo Buy Or Not To
Buy

• Top 3 stated reasons1 to invest in 130/30
• Diversification benefit
• Higher return potential
• Relationship with current manager
• Top 3 stated reasons1 to avoid 130/30
• Inadequate risk management
• Higher fees than long-only
• Higher risk / inadequate operations

1 Lehman Brothers, Alternative Equity Survey
Results, August 2008
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The View From This Year

• Investors managers following through on their
  interest
• With high adoption and recent weak performance,
  interest has cooled

Source www.allaboutalpha.com
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Risks Complexities - Today

• Counterparty risk
• Collateral pools securities lending
• Short sale constraints
• Naked shorting ban
• Outright ban
• Sub-optimal portfolios
• Return of the Uptick rule?
• Borrowing / Financing Costs
• TD vs SD
• Divergent credit / debit base rates
• Trading Costs

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Thoughts For The Future

• 1.46 lag behind long-only strategies -22.0
  return in SP 500 Cooling interest in 130/30
• Original premise still holds, if manager has
  stock selection skill, otherwise you just magnify
  the underperformance

• Pros
• Deleveraging / exiting the business more supply
• New entrants to lending market

• Cons
• Costs have increased recently with market turmoil
• Financing / credit rates
• Hard-to / unable-to-borrow
• Trading
• Shrinking supply?