Registered Rep. sat down with Mike Coffey to discuss 130/30 mutual funds, Mainstay's latest offering for advisors and an emerging trend among asset managers. The portfolio goes 100 percent long, and 30 percent short. The proceeds from the short sales are used to fund the purchase of another 30 percent of long positions.

RR: Dozens of money managers have recently set plans to launch 130/30 funds. And institutional clients have been hot for them. What is driving interest?

MC: Few institutional clients expect the equity markets to deliver the returns experienced over the past two decades. 130/30 strategies provide the potential to generate higher returns for the same amount of risk relative to the benchmark, while preserving the strategic asset allocation.

RR: Fairly or unfairly, these products will be compared to hedge funds due to the shorting component.

MC: This is not a hedge fund. This is just taking a long-only strategy and adding shorts to it without an exotic derivate strategy. It's not an option spread, market neutral or a fund of funds. It's indexed through an equity benchmark like any other equity fund. We're not seeking to neutralize market returns or offset a down market. It's really just to fill that traditional equity category with a different type of investment that offers comparable risk, with increased opportunity for return.

RR: Why bring 130/30 funds to the retail market? Isn't shorting for sophisticated investors who can take on more risk?

MC: There is a growing convergence of the retail and institutional [worlds]. This opens up a whole new opportunity set [to retail investors] not just to take advantage of stocks that the manager particularly likes, but also ones that may have a negative forecast. There's merely a perception of greater risk. It's important to evaluate the risk of the investment overall, and to not just look at the shorts. Because a mutual fund that's long only could have the identical risk profile of a 130/30 fund. And you can't focus on just the shorting — it's really a small percentage of the overall portfolio.

RR: Why 130/30? Ho do you know this is the right formula?

MC: As you add shorts to a portfolio, research has shown that you get the biggest bang for your buck with 120/20 to 130/30. After you start adding more shorting capability, your incremental alpha gain is somewhat more limited. Also, within a retail mutual fund, the level of comfort with shorting or leverage has been around one-third of portfolio assets, and this fits very nicely with that.