A strategy that’s popular with hedge fund investors is now being applied to an exchange traded note (ETN).

JP Morgan Chase & Co. ETN 130/30 (JFT) tracks
the First Trust Enhanced 130/30 Large Cap Index and replicates the
long-short strategy. Although this strategy is usually appreciated by
hedge fund investors, many fund providers are picking up on it. A
130/30 strategy allows the fund manager to leverage outperformance or
"alpha", through shorting stocks.

An ETN is a debt instrument, listed on an exchange, and tracks an index. They differ from exchange traded funds (ETFs) in that they are securities that represent a promise from a bank or financial institution to pay the holder the return of a specified index, minus expenses, reports John Spence for MarketWatch.

The 130/30 method allows the manager to begin with a sample of stocks and ranks them on their attractiveness as investments.The portfolio manager would then invest 100% of the stocks, and then short-sell the 30% lowest-ranking stocks. The shares are loaned out to investors and the short stocks are betting against the market. When the price of the short stocks decline they can buy them back at a later date and keep the difference.

The manager then takes that profit and puts that 30% back into the 100% long portfolio.

The key to such a fund’s success? The manager has to be good at stock picking. Other ETF providers have filed for their own 130/30 funds, and watching how they all perform relative to one another could be illuminating.

Tags | ETNs