Do 1980s' timing strategies still work?: "definitely." (short-selling and market-neutral fund) (Pension Fund Management )

• Author: Klingler, Jack

DURING THE 1980s, short-selling became an investment technique with genuine muscle. Although its returns have plunged in the last few years, scaring off many institutional investors, some believe short-selling is still a valuable diversification technique. Recently, market-neutral strategies have emerged as investment tools with considerable diversification clout. To help you decide what's best for your pension fund, investment experts from two top U.S. companies explain why they vote yea or nea on short-selling and market-neutral strategies.

At Alcoa, we have both a short-seller fund and a market-neutral fund in our portfolio because we think they're good methods of increasing diversification and returns. The short-seller fund is managed by eight short-seller managers, and its performance is negatively correlated with the S&P 500. The market-neutral fund is managed by nine different investment managers and is called market-neutral because its performance should be relatively neutral or uncorrelated with the performance of the S&P 500.

Our short-seller fund is designed to reduce the overall volatility in the portfolio through its negative correlations with the S&P 500. In addition to this fund's diversifying characteristics, it has, at times, shown surprisingly good returns, although not so much over the last few years. Thus, it can enhance portfolio return while giving downside protection, unlike traditional hedging vehicles like put options.

An interesting component of the performance is the short-sellers' rebate. The rebate is the share of the money earned by the managers on the proceeds from the sale of the stock that's been shorted. It works like this: The short-seller identifies the stock that's overpriced relative to its value and borrows the stock from a broker. He then sells the borrowed stock through the same broker,and the proceeds of the short sale earn interest at a broker loan rate, which is currently approximately 5 percent. The short-seller receives about 80 percent of the 5 percent, or 4 percent annualized, as a rebate, which is normally not given to small investors. This rebate helps bolster a short-seller's returns, even in rising markets.

AN UNCROWDED MARKET

Another attraction of short-selling is that relatively few dollars are invested in it. Our managers estimate that the total across the United States is probably less than $30 billion, and a significant proportion of that is the short positions of hedge funds. If you...