Reinventing the core: The role of fundamental extension (140/40) strategies

Are we again headed toward single-digit equity returns as the new norm? Extension strategies may help improve the outlook by generating viable alpha and enabling investors to achieve “more from core.”

Views expressed are those of the authors and are subject to change. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. Your capital may be at risk. Please refer to any investment risks noted near the end of the content available for download below.

Key points

We believe extension approaches may:

  • Be appropriate options for investors looking to get more from their core equity allocations (high active share) without taking on significantly more tracking risk;
  • Be a potentially higher alpha alternative to passive and long only approaches; and
  • Offer a differentiated idea for clients who are rethinking their US, global, and international passive exposures, or who are disappointed with their large-cap core allocations.

We cannot think of many competitive endeavors in which doing next to nothing turns out to be a winning strategy. Since the global financial crisis, a passive approach to US large-cap equities has been one of them. Consider this — over ten years through 2019, the S&P 500 Index has1:

  • Generated an annualized total return of 13.6%, significantly outperforming inflation and the long-term real-return targets of most institutions;
  • Outpaced both lower-risk and higher-risk asset classes, including US small-cap, non-US, and emerging markets stocks, US and non-US bonds, commodities, cash, and many other liquid asset classes;
  • Outperformed most active US large-cap core managers, ranking in the 17th and 11th percentiles of active managers for five and 10 years respectively, with lower turnover and lower fees;
  • And over the same period, the typical index fund has accomplished all of this with little tracking risk and no style drift, producing a remarkably consistent record of relative returns.

The last two points, in particular, have not been lost on institutional investors. A growing number have given up on active management of US equities, and focused their attention (as well as risk and fee budgets) elsewhere. But the first two points also are relevant. The extraordinary outperformance of US large-cap equity beta has helped many diversified asset allocation plans achieve their overall return targets, and made alpha generation less important. With valuation levels and profit margins ending last year near historical highs, that relationship may…

To read more, please click the download link below.

1Source: FactSet; eVestment Alliance. As of 31 December 2019. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Indices are unmanaged and cannot be directly invested into.

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