While most of the new fund launches are ETFs these days, certain categories of mutual funds are popular breeding grounds for new old-fashioned funds. Funds that ‘short’ stock (borrow shares and sell them with the hope of buying them back at a lower price in future) are becoming increasingly popular with investors, and therefore fund companies are lining up with new offerings.
So far this category of ‘long-short’ funds is riddled with expensive but mediocre funds. Fidelity hopes to change all that with their new Fidelity 130/30 Large Cap Fund (FOTTX), launched this past week:
The main differences between a 130/30 fund structure and other funds is the use of leverage and shorting. 130/30 Funds employ a strategy of holding investments both "long" (or bought with the expectation that the stock will outperform the market) and "short" (or those borrowed and sold with the expectation that they will under-perform the market). This gives the fund manager the ability to further capitalize on stock selection skill by allowing him to fully express both positive and negative views on stocks...…Fidelity has a 15-year history of shorting stocks, mainly in institutional market-neutral portfolios.”
The fund’s minimum is an above average $10,000 for regular accounts, $2,500 for IRA’s and for purchases made through an investment advisor.
Keep in mind such a fund is NOT safer than a stock fund that is invested 100% in stocks. The core fees include management fees of 0.86% and other expenses of 0.37% for a 1.23% expense ratio BEFORE considering dividends owed on shorted stocks and other expenses related to shorting. With these fees total expenses are 1.89%. Note that dividends earned buying stocks with short proceeds is not deducted from quoted expenses so the 1.89% in some cases is a bit of an overstatement.
If this fund were to short stocks and invest the proceeds in say, government T-bills, investors could see some risk reduction as their overall portfolio would have net exposure to the stock market of under 100% (though there would still be risk the shorts would go up while and the longs down resulting in a risk profile of 100% long).
However, this fund and many like it take the proceeds of the shorts and buy more stock. This is even riskier than borrowing the 30% to buy more stocks (130% long) like many closed end funds do because there is a risk that both the shorts and the longs will lose money – in some cases an investor could have the risk profile of being 160% in stocks if the longs and shorts picks by the fund manager both perform poorly. In fact, since an investor can lose more than 100% of their money on a short, in theory this fund could approach the risk profile of being 200% in stocks, though I’m sure Fidelity would disagree with this assessment.
Risk warnings aside, this and other similar funds have a key advantage over individuals shorting stocks: use of short proceeds. Most investors not only have to keep the proceeds of the short with the broker, they may have to pay margin interest or put some of their own cash up against the short to cover the risk to the broker. Funds get to invest the proceeds of the short and put up the rest of the portfolio as collateral.
We expect this fund to perform in the top 20% of similar funds over the next year because the fees are lower than many others and Fidelity will be doing everything in its power to make sure this new small fund performs well.
For more on this new fund check out Fidelity’s website.
