Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 26: Buy-Write Strategies]
While anyone can simply go long the broad market to gain exposure to long-term growth, investors can also consider the 130/30 ETFs’ alternative strategy that exploit opportunities within the marketplace to generate excess returns.
ETFs that follow the 130/30 strategy will utilize quantitative analysis to select attractive stock picks and identify a group of less desirable stocks.
The funds will first invest 100% of the portfolio into the best ranked picks and sell short up to 30% of the bottom ranked stocks. Any cash earned from the short sales would be put back into the top picks. The end result will create a type of long-/short-strategy that will generate a 130% long position for the top performers of a given index while maintaining a 30% short position on the least appealing stocks of the index. [What is an ETF? — Part 20: Long/Short Strategies]
By taking on a higher long position while shorting weaker stocks, the funds seek to generate alpha, or outperformance. For instance, the ProShares Credit Suisse 130/30 (NYSEArca: CSM), which tries to reflect the performance of the Credit Suisse 130/30 Large-Cap Index and overlaps with much of the S&P 500 universe, has gained 16.6% year-to-date, whereas the S&P 500 has increased 15.6% year-to-date.
Additionally, investors may consider the First Trust Enhanced 130/30 Large Cap Index ETN (NYSEArca: JFT). JFT tracks the First Trust Enhanced 130/30 Large Cap Index, which is a modified equal-weighted total return index that selects stocks from a universe of 2,500 largest U.S. stocks. Investors should also be aware that this is an ETN and not an ETF. [What is an ETF? — Part 12: Exchange Traded Notes]
For past stories in this series, visit our “What is an ETF?” category.
Max Chen contributed to this article.