130/30 ETF (CSM) Continues To Impress

by on June 10, 2010 | ETFs Mentioned:

As ETFs have growth from a closet industry to a primary element of the investing landscape, the number of products available to U.S. investors has surged, rising to more than 1,000 over the last two years. Many of the new products to hit the market in recent years have been twists on the most popular members of the first generation of ETFs, altering the weighting methodology or selection criteria underlying well-known stock and bond benchmarks.

As perhaps the best-recognized index in the world, the S&P 500 is the basis for the the largest U.S.-listed ETF by total assets (for the time being at least); current assets in ETFs linked to this benchmark exceed $80 billion. The S&P 500 has also inspired a number of “spin off” ETFs, including an equal-weighted fund, revenue-weighted fund, and a product linked to a gold-hedged version of the index (see Nine Alternative S&P 500 ETFs).

One of the more interesting twists on the S&P 500 came last year with the introduction of the ProShares Credit Suisse 130/30 (CSM), the first ETF to offer exposure to a 130/30 investing strategy. CSM seeks to replicate the Credit Suisse 130/30 Index, a benchmark that utilizes limited shorting and leverage in an attempt to take advantage of both positive and negative movements in stock prices. While the exact methodologies used to construct the index are somewhat complex, the general idea behind a 130/30 fund is relatively straightforward. First, 30% of the portfolio is sold short, and the proceeds from the short sale are then used to increase long exposure to 130%, resulting in net market exposure of 100% long. In the case of CSM, the universe of eligible securities includes the 500 largest U.S. stocks, meaning that the risk profile will be similar to the S&P 500.

The goal is to short index components expected to generate negative alpha, and use the proceeds to establish overweight positions in those that will generate positive alpha. If that objective is accomplished, a 130/30 fund will likely outperform the related long-only benchmark. But if the best performers are shorted and the proceeds used to double down on laggards, the strategy could underperform (see this Guide To 130/30 ETFs).

The concept of 130/30 investing is nothing new, but its availability in the ETF structure is a relatively recent development. Although CSM’s track recordĀ  is limited, the early results have been impressive. Since its inception CSM has outperformed SPY by about 200 basis points, more than making up for a higher expense ratio (CSM charges 0.95%, compared to 0.09% for SPY). Through Wednesday, CSM was down about 5.5% for the year, compared to a decline of 6.4% for SPY.

Under The Hood

Sector Long Short
Technology 25.0% -5.4%
Financials 21.3% -5.2%
Discretionary 16.3% -4.3%
Staples 15.4% -0.7%
Health Care 13.7% -3.2%
Energy 10.8% -2.8%
Industrials 10.6% -3.4%
Utilities 8.7% -2.5%
Telecom 4.1% 0.0%
Materials 3.9% -2.4%

Because CSM’s universe of eligible components is the S&P 500, the overlap and correlation between the 130/30 ETF and SPY will generally be significant. The list of CSM’s top ten holdings looks a lot like the SPY’s holdings; Exxon Mobil, Apple, Microsoft, and AT&T are all smong the stocks receiving the biggest allocations.

From a sector perspective, the allocations between the two funds are similar as well; technology makes up the largest percentage of both. Each of the short plays made by CSM involves relatively small positions; MEMC Electronic Materials is the largest short position in the underlying index at about 0.4%, and only a few companies receive a short position of more than 10 basis points.

So CSM’s outperformance has been the result not of any big sector bets or short plays, but rather many minor differences in weightings that have added up to create a sizable delta.

Most investors seeking exposure to large cap equities gravitate towards cap-weighted benchmarks such as the Russell 1000 or S&P 500. But the rise of the ETF industry has created a number of easy-to-access alternatives. For those looking for a fund with a risk/return profile similar to the S&P 500 but with the potential to generate excess returns, CSM might be an interesting option.

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Disclosure: No positions at time of writing.