InvescoQuantitative Strategies

130/30 StrategiesPast & Future

The information presented is for informational purposes only and should not be used for investment purposes. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments there are inherent risks. Please obtain and review all financial material carefully before investing. Past performance is not indicative or future results. This does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed herein are based on current market conditions and are subject to change without notice.

For Prospective Institutional Client and Consultant Use Only2

“130/30” Basics

• Many names for same thing: 130/30, Short Extension, Extended Alpha, Directional Long/Short, Active Extension

• 1X0 / X0:• Long 1X0% in stock• Short X0% in stock

• Goal: Potential for greater returns by taking more meaningful active underweights

• The problem:

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

5.00%

1

51

101

151

201

251

301

351

401

451

Nth name in S&P 500, ordered by decreasing size

S&

P 5

00

weig

ht

Source: Standard & Poor’s, Invesco

Median weight = 8 bp’s

For Prospective Institutional Client and Consultant Use Only3

Long-Only Constraint Can Hinder Alpha Transfer

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- 1.50

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- 0.50

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2.50

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 101 105 109 113 117

Individual Holdings

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ion W

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%

• Highly diversified portfolio of 120 stocks• The portfolio lacks symmetry• The ability to generate alpha is focused mostly on stocks the manager

expects to outperform

For illustrative purposes only.

An illustration of active position weights for a representative long-only portfolio

For Prospective Institutional Client and Consultant Use Only4

Improved Linearity In Portfolio Construction

- 1.5

- 1.0

- 0.5

0.0

0.5

1.0

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2.0

1 14 27 40 53 66 79 92 105 118 131 144 157 170 183 196 209 222 235 248 261 274 287 300 313 326 339 352 365 378

Individual Holdings

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• Underweighting the least attractive stocks with the same degree of conviction as those stocks overweighted

• Highly diversified portfolio of about 400 stocks

• Long (overweighted and underweighted positions)

• Short positions

For illustrative purposes only.

Illustration of active position weights for a a representative 130/30 portfolio

For Prospective Institutional Client and Consultant Use Only5

Advantages of Relaxing the Long-Only Constraint

• Higher excess return potential• If investment insights are accurate, expect excess returns to increase

by up to 50% over a comparable long-only strategy1

• Higher potential tradeoff of excess return to excess risk• Improvement due to more active weights (bets) on greater number of

positions with the freedom to be long or short

• Capital is fully invested and used more efficiently• Allocation of active bets is proportional to expected return• Short positions allow more efficient allocation of risk

• Harnesses manager stock selection and portfolio construction skills

• Greater flexibility to capture investment insights without • being entirely constrained by the benchmark

1 Returns are net of estimated costs of trading but gross of management fees and leverage costs

For Prospective Institutional Client and Consultant Use Only6

Mechanics Overview

• $130 long and $30 short for $100 of capital

• Reg T limit = 2:1 maximum leverage• 150 / 50 maximum under Reg T using Standard Prime Brokerage• Standard vs Enhanced Prime Brokerage

• Costs• Financing cost: Must pay interest on borrowed capital (Fed Funds

+ x)• Short proceeds: Receive interest on short sale proceeds less

“haircut” (Fed Funds - y)• Total cost = x + y

• Stock borrow considerations• Prime Broker as traditional source• Hard-to- / unable-to-borrow raises cost / lowers returns• Cost subject to change over time• Pre-borrow, firm locates, time limit

For Prospective Institutional Client and Consultant Use Only7

Provider Types & Benefits

Quant

Fundamental

Traditional Asset Manager

Hedge Fund

Pros ConsExperience forecasting negative future return Black box/GIGO

Risk Control/portfolio optimization Exposed to emerging/singular risks

Breadth Depth

Pros ConsConviction Diversification

Judgment on new companies Emotional trading

Depth Breadth

Cons Pros

Pros ConsShorting Expertise/Infrastructure Fees

Access to borrow Liquidity/Transparency

Strategies with shorting = sole business Investment horizon/Incentives

For Prospective Institutional Client and Consultant Use Only8

Risks & Complexities130 / 30 vs Long-only

• Leverage• Long and short investments exceed investors’ capital

• Market risk is not leveraged

• Short Selling• Downside is theoretically limitless

• Expertise in identifying shorts

• Availability to Borrow (rebate risk)

• Liquidity (short squeeze)

• UBTI• Income earned by a tax-exempt entity that does not result from tax-exempt

activities, such as earnings on assets financed with borrowed funds

• Prime Broker Relationship• SEC oversight but not a fiduciary

• Counterparty Risk

For Prospective Institutional Client and Consultant Use Only9

The “Early” Days

• Early providers• “Gray beards” launched 130/30 in 2000 (DuPont Capital - June, 2000)• Mostly quantitative equity managers • Per eVestment Alliance: only eight offerings by year-end 2004; 64 by year-end 2007

• Interest from consultant / plan sponsor side• Opportunity to capture better returns• Able to maintain relationship with trusted long-only provider• Remain exposed to the market• “Dipping your toe” in the alternatives pool

• Use of strategies• Long-only vs. alternatives bucket• Standard vs. 130/30 benchmark

• Strategy benchmarks• Large cap (S&P 500 & Russell 1000) dominates1

• 6 of the 8 (75%) of those launched by 12/31/04• 44 of the 64 (69%) of those launched by 12/31/07

• Asset growth & projections• AUM growth2, 1Q07 – 3Q07: 77%• AUM growth3, 3Q07 – 1Q08: 22%• Projected AUM growth4: $1 Tr by 2011

1 eVestment Alliance, 11/21/082 Pensions & Investments3 Pensions & Investments4 Pensions & Endowments 21, Institutional demand for 130/30, Gordon J. Latter and John Haugh, Merrill Lynch, 8 January 2008

For Prospective Institutional Client and Consultant Use Only10

The View From Last Year

• Small but not insignificant early adoption rate

• Strong interest in strategy from both investors & managers

Source: www.allaboutalpha.com

2007

16%

16%

31%

26%

0% 10% 20% 30% 40% 50%

Managers

Investors

Implemented currently

Considering in next 12 months

For Prospective Institutional Client and Consultant Use Only11

Results – 130/30 Strategies“Long-Term” Vs Short-Term

• Long-term is relative

•130/30 Managers slightly behind benchmark over last year

•Results better over “long-term”

Source: eVestment Alliance

Period Ending 9/30/08 Period Ending 9/30/07

1 Yr 3 Yrs 2 Yrs

Median, all managers -22.01 0.88 14.41

S&P 500 -21.98 0.22 13.58

Difference -0.03 0.66 0.83

# of Observations 68 12 16

For Prospective Institutional Client and Consultant Use Only12

Results – Long-Only Strategies“Long-Term” Vs Short-Term

Source: eVestment Alliance

•More crowded space

•Near equal to 130/30 over three years

•Better performance over last year

•Contrary to expectations

Period Ending 9/30/08 Period Ending 9/30/07

1 Yr 3 Yrs 2 Yrs

Median, all managers -20.55 0.89 13.59

S&P 500 -21.98 0.22 13.58

Difference 1.43 0.67 0.01

# of Observations 348 339 383

For Prospective Institutional Client and Consultant Use Only13

Current State of 130/30 Market

• AUM & recent growth

• AUM1 as of 9/30/08: $54 bil

• AUM2 as of 9/30/07: $54 bil

• Market-adjusted inflows, last 12 months: +$15 bil (+28%)

• Institutional investors’ attitudes:

• 70% say investment in 130/30 will remain unchanged in 2009 from current levels3

• 9% intend to add 130/30 to their portfoios4

• Satisfaction rating5 3.8 / 5 for 130/30

1 Pensions & Investments2 Pensions & Investments3 FUNDfire, 11/12/08, based on a recent survey from Morningstar and Barron’s.4 JPMorgan Asset Management5 Lehman Brothers, Alternative Equity Survey Results, August 2008

For Prospective Institutional Client and Consultant Use Only14

Current State of 130/30 MarketTo Buy Or Not To Buy

• Top 3 stated reasons1 to invest in 130/30

• Diversification benefit

• Higher return potential

• Relationship with current manager

• Top 3 stated reasons1 to avoid 130/30

• Inadequate risk management

• Higher fees than long-only

• Higher risk / inadequate operations

1 Lehman Brothers, Alternative Equity Survey Results, August 2008

For Prospective Institutional Client and Consultant Use Only15

The View From This Year

• Investors & managers following through on their interest

• With high adoption and recent weak performance, interest has cooled

Source: www.allaboutalpha.com

2008

11%

7%

59%

40%

0% 10% 20% 30% 40% 50% 60% 70% 80%

Managers

Investors

Implemented currently

Considering in next 12 months

For Prospective Institutional Client and Consultant Use Only16

Risks & Complexities - Today

• Counterparty risk

• Collateral pools & securities lending

• Short sale constraints• Naked shorting ban

• Outright ban

• Sub-optimal portfolios

• Return of the Uptick rule?

• Borrowing / Financing Costs• TD vs SD

• Divergent credit / debit base rates

• Trading Costs

For Prospective Institutional Client and Consultant Use Only17

Thoughts For The Future

• 1.46% lag behind long-only strategies +-22.0% return in S&P 500 = Cooling interest in 130/30

• Original premise still holds, if manager has stock selection skill, otherwise you just magnify the underperformance

Pros

• Deleveraging / exiting the business = more supply

• New entrants to lending market

Cons

• Costs have increased recently with market turmoil

– Financing / credit rates

– Hard-to / unable-to-borrow

– Trading

– Shrinking supply?