If markets are really heading into the sweet spot for 130/30 funds, which ETP is right for you?

As Daniel Harrison observes in his Streetwise column Thursday, conditions seem to be setting up rather nicely for quant exchange-traded products. In particular, these could turn out to be more profitable times for 130/30 strategies.

Daniel focuses on the latest to come out of the gates, and the first exchange-traded fund – the ProShares Credit Suisse 130/30 Index ETF (NYSEArca: CSM).

Facing high expectations in some corners, the ETF has been sluggish coming out of the gates. As Daniel points out, though, CSM’s quantitative process has made a number of moves in terms of shorting certain names and going long on others that explain its early performance.

But it might be important to note that while CSM is the first 130/30 ETF, it’s not the first ETP to use such a hedging scheme. The first-to-market in such ETPs was the First Trust Enhanced 130/30 Index (AMEX: JFT). The exchange-traded note launched in May 2008. And it has been outperforming CSM in the short time both have been around (CSM came out in July 2009).

Heading into Wednesday, JFT was up nearly 25 percent so far this year.  Besides being structured as an ETN, the First Trust fund has some other key differences with CSM.  One of those is that it uses a different set of growth and value factors to mechanically decide what stocks to go long.

Growth factors used by the ETN’s JPMorgan Chase index are: three-month, six-month and 12-month price appreciation. The other growth factor is one-year sales growth.

The other half of the picture is the selection process for value names added to the ETN's underlying index. Those are ranked by factors including: book-to-price, cash-flow-to-price and return-on- assets. Also, aggregate rankings of both the growth and value factors are included in long positions.

The long positions are chosen from top-ranked stocks in a universe of 2,500 large-caps. Besides the combined value and growth factors, the index tries to weed out names based on certain liquidity screens. No ADRs, REITs or limited partnerships are generally included.

The ETF’s short positions simply reflect the lowest-ranked stocks in the methodology. The complete process is repeated and names adjusted each quarter.

CSM tries to build-in alpha by using a proprietary quant-based model. Just like JFT, the Credit Suisse index used by the ProShares ETF uses a methodology that crunches a number of different data. But unlike JFT, the CSM index uses 50 different factors grouped into 10 equally-weighted groupings: traditional value, relative value, historical growth, expected growth, profit trend, accelerating sales, earnings momentum, price momentum, price reversal and size.

Also, as Dan points out, CSM makes changes to its portfolio monthly. Looking at the outperformance by JFT – again, under a very short timeframe – no doubt relates to the differences in indexing methodologies. For example, CSM’s portfolio has relatively large positions in cash and swaps -- agreements between ProShares and a third-party financier who agrees to exchange payments based on the movement of the underlying index.

JFT physically takes positions in all its holdings. It had none listed in cash through Tuesday. In this market, that’s probably been a plus. Also, CSM has roughly twice as many long positions as its ETN competitor. It also has slightly more short positions, but the differential is much closer.

With Direxion expected to come out with its own 130/30 ETF strategy (see story here), this is a market that’s likely to expand as hedging strategies trickle down to more mainstream investors.

Murray Coleman is editor of IndexUniverse.com. He welcomes comments and suggestions for future blogs at: This e-mail address is being protected from spambots. You need JavaScript enabled to view it .