This time things will be different for systematic extension strategies, argues Acadian Asset Management.
Also known as 130/30 strategies, systematic extension strategies involve investing in a basket of stocks, shorting another basket of stocks, then using the proceeds of those short positions to increase the long exposure.
The strategy faltered during the Global Financial Crisis, but could be ripe for a comeback as asset owners search for yield in a tough equity market.
“Systematic extension strategies offer a disciplined method of boosting active exposure,” according to a paper from Acadian. “But they have been underutilized for years due to hazy perceptions of their underperformance around the Global Financial Crisis and a blurry leeriness of risks associated with shorting.”
The name 130/30 denotes the percentage of the portfolio dedicated to long positions (130 percent) and short positions (30 percent). Fund managers then use the short sale proceeds to increase their exposure to the long positions, effectively allocating 130 percent of a fund’s assets to high-conviction long positions. In other words, it’s a cheaper way to put more money to work. At Acadian, this is a quantitative investment strategy that relies on algorithms to identify investment opportunities.
“What you’re doing here is increasing exposure to mispricings that you can identify in the market,” said Sean Geary, portfolio manager at Acadian. Acadian sees systematic extension strategies as a good alternative for an investor who wants the returns of a concentrated active manager, without the risk of taking just a few portfolio positions. Acadian’s application of 130/30 strategies involves significant diversification, which avoids some of the risk of concentration.
But some investors are still hesitant. After all, they remember what happened during the Global Financial Crisis. Researchers in 2007 predicted that 130/30 strategies — once dubbed “The New Long-Only” — could see their market share soar from $75 billion that year to $2 trillion by 2010. Asset managers piled into this corner of the market, eager to tap into high potential returns.
That didn’t happen. Like portable alpha strategies — and actively managed funds by and large — during the GFC, 130/30 funds were plagued by underperformance. Many 130/30 funds were quant-driven, and their models couldn’t handle the volatile market swings. So they underperformed.
According to the Financial Times’s 2013 mea culpa on the strategy, systematic extension strategies reached their final peak in 2010 — at just $9.4 billion.
But as asset owners seek to add alpha to their portfolios while mitigating risk, these strategies could come back into vogue. At least, Acadian Asset Management believes that could be the case. The firm has been running systematic extension strategies since 2003, riding several market cycles. Now could be the strategy’s time to shine.
Allocators are “motivated by concern that lack of beta won’t get investors where they need to go,” according to Seth Weingram, Geary’s colleague at Acadian who serves as a senior vice president at the firm.
In his view, part of what propelled 130/30 strategies downward in the mid-aughts was a rush of “rudimentary” quant products that did not have the sophisticated risk management tools that today’s strategies have implemented.
According to Geary, Acadian’s short books are “very diversified” and include hundreds of stocks, which the team believes can reduce some of the portfolio’s overall risk. The model Acadian uses also filters out meme stocks, effectively avoiding some of the problems that arise when hype, rather than true value, drives up a stock’s price.
“When you think about what has been reported on or visible to investors, they think of Reddit and GameStop most recently,” Geary said. “We get questions about dealing with that. Those types of scenarios are the ones that we don’t like to play in.”
The results have been good so far.
Acadian compared its implementation of the strategy to both a long-only baseline portfolio and a long-only portfolio that includes 1.6 times leverage. For the period between February 2007 and March 2022, the 130/30 strategy posted higher average active returns compared to both portfolios. This was done with lower active risk than the 1.6 times leverage portfolio.
Acadian also noted that these extension strategies can increase an asset owner’s exposure to small-cap markets without piling on more risk.
“We think that ability to control risk very clearly is an attribute of a systematic approach that gets undervalued,” Weingram said.
