120/20 Funds - More Wall Street Gimmicks

The Wall Street crowd is at it again. Their latest gimmick is the 120/20 fund, a concept dreamed up by quantitative analysts and fund managers, the so called "quants". It works like this. A fund manager buys a basket of stocks to hold - known as long positions. Then the manager sells short a smaller basket of stocks - know as short positions. Using the proceeds from the short sales the manager buys more stocks to hold as long positions. The net result is that about one-hundred percent of he fund's money is invested in long positions. And if the short positions decline in value, the manger can buy them back for a profit thus boosting the fund's total return. But if the short positions increase in price, the fund must buy them back at a loss.

The concept of selling short and using the proceeds to add to long positions is not new but packaging it for retail investors is new. But beware. The 120/20funds have no long-term track record so we do not know if they are worth all the fuss.

Also many 120/20 funds charge very high fees which will reduce their total returns particularly for long-term holders of the funds. For example, the Goldman Sachs Structured U.S. Equity A (GSSQX) charges an exuberant 5.50 percent front-end sales load to buy the fund, a 1.09 percent annual fee and an 0.25 percent fee to market the fund. So in the first year that you own the fund you will pay 6.84 percent in fees!!! This means that the fund would have to outperform the S&P 500 by almost seven percentage points just to match the returns of a low-fee index fund that tracks the S&P 500.

There is no good reason to own any of these 120/20 funds. Instead buy low-fee index funds and exchange-traded funds.

Related Articles:

Selling Short
Buying on Margin

Posted December 6, 2006.