Transcript: A Missing Dimension in Equity Portfolio Design

Air Date: January 26, 2026 | 12:00 PM, EST

Good afternoon, everyone, and thanks for joining us. On behalf of the Canadian Leadership Congress, I'd like to welcome you to this week's Monday Minute Chat. My name is John Spinney, chief investment officer with Vesper, and I'm going to be your moderator today. Our topic is a missing dimension in equity portfolio design. Joining us to discuss this is Seth Weingram, senior vice president and director of client advisory at Acadian Asset Management.

Welcome, sir. Thanks so much, John.

Okay, so so let's dive right into it. I work at an asset owner and we deploy active quant strategies across the globe. So I'm familiar with the ongoing challenges in the search for alpha. It seems like markets continue every year to become more competitive. And additionally, with the increasing levels of concentration in the US equity markets these days, in particular, it's natural that investors would be looking to make improvements in how they structure portfolios to maximize their alpha and also avoid having unintentional risks creep into their portfolios.

Although it all starts with the signals driving stock selection. Portfolio construction matters also in terms of maximally unlocking the insights from stock selection. With that brings us to our topic for today concerning extension strategies. So with all that being said, from your perspective, sir, what do you think has been the most important factors in driving this renewed interest we've been seeing in long short extensions extension strategies across the globe?

You know, John, I think you touched on it in, in your introduction. And thanks very much for that. Certainly over the years, investors have sought higher active returns from their portfolios and as time changes, as market circumstances change, the particular reasons why evolve as well. And in this era, I think there is certainly some skepticism of market data.

Is market beta going to get asset owners and allocators to the ambitious performance targets that they have? And that notion of concentration of benchmarks, certainly plays into that to some extent. How much confidence do you have that the performance that has driven just a handful of stocks to preeminence and the benchmarks that we have is going to continue. To what extent can we bank on that in terms of driving index performance going forward? And so as people think about those issues in the current environment, that fuels some skepticism as to whether or not, passive allocations, if you will, are going to get them where they need to, where they need to go. And as one allocator, mentioned on a recent panel that I was involved in, that plays into some of the alternative methods that people have been looking at in order to try and generate performance as well.

And he was focusing, for example, on private equity, where he was saying effectively, you know, look, we've been increasing our allocation to private equity for many years now, but we're kind of at the point where we're full up on private markets exposure. And in fact total equity beta exposure. So at this point, we're looking around for things that we can do in order to amplify the returns that we get from our public equity allocations.

And in that sort of context, there's another, theme that plays into this as well, where over the last decade or so, we certainly saw allocators turning to concentrated discretionary stock picking in order to try and juice up the active returns that they were getting from their portfolios. But over the last few years, many of those strategies have stumbled.

Some of the growth oriented drivers that people were looking at, certainly in 2022, they there were some issues there, as well. And so over the last couple of years, to the benefit of systematic managers, generally speaking, we've heard a lot of skepticism about the ability of those concentrated discretionary managers to actually generate excess returns during a broad set of market environments.

So I think those are a couple of the themes that have been driving the particular interest in extensions, and in particular, systematic extension strategies in the current iteration of markets that we're living with today. Okay, that that's really interesting. So as usual, a lot of market factors driving behavior in a certain direction. Maybe before we go any further though, we could just kind of bring it back to the basics or level set a little bit.

Let's just talk about these systematic strategies. What do you think are the main benefits for an alpha seeking strategy like that? You know, one 3030 type structure versus the traditional longonly approach. How are you? How do investors benefit by relaxing that long on the constraints?

Yeah, I think the way that I would summarize it in one succinct statement is that especially for Systematic Manager, a long, short extension strategy simply allows on short extension strategy allows the manager to make more complete and more effective use of the alpha generating views that it already has that it can implement via a long only portfolio.

And let's think a little bit about how that is the case, why that is the case. And in doing so, we're going to be a little bit conceptual. And I would say that the key point is to recognize that a long only portfolio is unlikely to be the optimal representation that an investor could construct, that the systematic manager could construct from a set of risk and return forecasts across some universe of stocks.

Now, why do I say that? Well, let's say that you've got a portfolio and, you're forming a portfolio and you require that it be net 100% long, 100% net long, and have a beta of one, and you're going to construct the portfolio, you're using mean variance analysis. And it's not special that we're talking about mean variance analysis here.

It's just one particular method of portfolio construction. Now if you allow some shorting within this framework, it's highly unlikely that the portfolio that the optimal portfolio that you would form from the set of all the stocks that you can choose from would be long only you're almost surely going to find that a portfolio with some short positions is going to dominate along only portfolio.

You're going to get be able to generate more alpha for some permitted level of tracking error. Now the next question is why is that? And there are a couple of intuitive reasons for it. First of all, if you don't allow shorting, then you're effectively throwing out a lot of the views the manager has. So let's say that you've got, you know, a broad universe of stocks.

You're talking about a systematic manager that has, views on across that universe of stocks. What you're effectively doing by imposing the long on the constraint is you're saying, okay, I want you to throw away, say, half of the views that you have on the stocks. Now, that's very, important. And in the context of the benchmarks that we have, you can kind of see why.

Because the only way that the manager can, can express negative views on stocks is by understating them relative to the benchmark. But if you think about these highly concentrated benchmarks that we have today, most of the vast majority of stocks have negligible weights in the MSCI US EMI index, for example, they're about 2200 stocks. It's behaving more like it has about 60, stocks in the index.

And the vast, vast, vast majority of those stocks have essentially weights that are very, very close to zero. So there's very little ability for the manager to actually express negative views on stocks that are in the portfolio. And for stocks that might be in the investment universe outside of the benchmark, there's no way to express negative views whatsoever.

Now, not only are you asking the manager to throw away, you know, roughly half of its views, something like that, but you're also distorting the manager's ability to implement positive views that it has on stocks that are in, in the index. And the reason why is that in order to express any positive views on stocks, you have to find underweight in order to implement them.

And if you don't allow shorting and as you don't allow shorting and you have to look for those underweight, what does it mean? It means that you have a limited set of stocks. You can actually extract those positive weights. And as a result, you're probably going to end up under weighting stocks that you have neutral or possibly even moderately positive use on in order to fund the overweight and stocks that you like even more.

And essentially this becomes a distortion in terms of the manager's ability to represent its views naturally in the portfolio and what it actually has a pragmatic, the practical ability that it has in order to represent, those views. So the long only for the long only constraint interferes with the ability to express views and portfolio. And it turns out that it's a pretty powerful, constraint.

In doing so, it's a very costly constraint in doing so. And so when you think about extension strategies, what you're effectively saying, at least in the context of a systematic manager who has this broad forecasting ability, you're saying we don't want you to do anything new in terms of forecasting. All we're going to do is we're going to relax the no shorting constraint, and that's going to allow you to more naturally implement the views that you already have in the portfolio.

So I think it's fair to say then that it brings a more, you know, an intentionality to risk taking in your portfolio by relaxing the constraints and avoiding unintended bets in your portfolio. And so, yes. Related related to that, I would say maybe this is a basic question, but those of us who have been around for quite a while know that, you know, there have been times in the past when extension strategies were discussed before, and one 3030 tends to be the number that keeps coming up.

Is there anything special about like that? 30% shorting allowance or in one 3030? Or should wejust have a more kind of generalized concept of allowing leverage in portfolio construction for these types of strategies? I'm going to digress here for just a minute with a little personal anecdotes. So back in the mid 2000 when extension strategies first, gained traction, I was on the sell side and I was working at, an investment bank, in New York in the derivatives world.

And we started hearing about these one, 30, 30 strategies and thinking, well, why one 3030? What's the special? You know, the special ratio there? And, actually, over the last couple of years, as extension strategies have regained, attention, we're hearing from asset owners that question like, why one 3030? It's become one of the first questions that we get asked.

And it turns out there is no special reason to focus on one 3030. I think the reason why one 3030 gain traction was pragmatic. It allows, a boost in expected returns, while still maintaining comfortable levels of tracking error and comfortable levels of leverage. So maybe you're taking tracking error up from 5% to 6%, or maybe 7% or something like that, but you're staying within the realm of what long only investors are traditionally used to.

And moving from zero leverage to 160% gross exposure or something like that, is again, relatively modest compared to alternative strategies. For example, compared to what hedge funds do. So I think you're staying within the comfort zone of many asset owners. But that laser focus on 130, that's sort of like, you know, the gravitational pull of that, particular level of gross leverage.

I think it's been a little bit destructive in that it's what we should be looking at in the context of extension strategies is a little bit more of a generalized concept. And, effectively, what we want to do is we want to start recognizing that leverage in portfolio design, we should think about it as a design choice. And you mentioned the word intentionality.

And I think that's really important. Let's think about the leverage that we're taking in portfolio design with the same level of intentionality that we think about two other parameters active return and active risk. If we start thinking about those three things as they're not independent knobs, but they're knobs that have sufficient independence that we can tweak them. And thinking about the trade offs between, let's say, two of them, if we hold the other one fixed, then, we can start thinking about creating portfolios that are more intentional as solutions for investors with a very wide range of different, very wide range of different needs and different predilections.

Yeah. That's interesting. A couple of things that come out of what you just said, I think, and I'll maybe deal with them in order. The first one you mentioned, risk or tracking error and maybe allowing you to target potentially higher levels, but it's not necessarily the case that you need to target higher levels of risk to make, extension strategies valuable.

Maybe just speak a little bit about risk. And, and you're thinking of how that, you know, relaxing that long only constraint impacts risk or market risk or tracking or in these strategies. Yeah. That's right. It's it's really important, I think, to realize that if you're thinking about, let's say you allow leverage to to very you start thinking about it a little bit more holistically, and you start from, say, 130, 30 strategy.

You say, okay, well, what happens if I go to one of 5050 or 160, 60? I think a lot of asset owners would think about that question initially in terms of a turbocharging of the one 3030 strategy, you just kind of ramp up the leverage. You leave other things constant. And if you are seeking alpha, if you're trying to maximize your active return in that one 3030 strategy with a particular level of tracking error, well, now you're going to allow yourself more tracking error and you're going to increase active risk, active return to your target of active return.

Even more. But that's not necessarily what you have to do. You could do that, but you don't have to do that. Essentially, if you increase your ability to take more leverage, then you're giving yourself flexibility to achieve different types of trade offs between active return and risk. And so one thing that you can do, for example, and this is, certainly something that's been popular interms of allocators that we've spoken to, is you allow yourself the freedom to take more leverage and you don't increase active risk that you're targeting.

What you do is you say, I'm actually going to start to reduce my active risk relative to a 130, 30, active strategy. And in doing so, I'm, going to, try to achieve a more stable, returns profile. So, for example, you start with one 3030, and you increase your, your leverage and, instead of allowing yourself to take greater and greater amounts of active risk, you force yourself to take actually a level of active risk that's commensurate now with a long only portfolio.

So instead of taking the active risk that you were taking with a one 3030 strategy, you squeeze it down even more. You squeezed out back to what a long only portfolio would look like. But you do that with the hopes of achieving a better, trade off between the amount of active risk that you're taking and the amount of active return that you're generating, and that's created by the fact that you're using greater degrees of leverage.

So you hope to improve the trade off between active return and active risk. But by allowing yourself more flexibility to take leverage. And how might you do that? Well, what you end up doing in portfolio construction there is you're effectively saying, I'm going to prioritize taking, diversify risk, in seeking my alpha by taking more, using more ability to short and forcing myself into more idiosyncratic bets, as in in the context of portfolio construction, I'm, in effect, going to, as you were suggesting, I'm going to reduce the amount of systemic risk in a variety of different forms, these, unanticipated, unintended, risk factor exposures that I would normally

get in my portfolio when I did use my greater ability to short in order to neutralize them. And that's effectively going to push more of my active exposure into these idiosyncratic bets. And as long as I have effective signals that can generate, that those, the expected return from those active exposures that I'm going to hope to generate a higher information ratio, a higher ratio of active return relative to active risk than I would get in a long only portfolio.

So you're not turbocharging the one 3030 strategy. You're using your greater degree of leverage very deliberately in order to actually bring down the level of active risk relative to one to the one, 3030 strategy and achieve a different, active return, active risk trade off. It's interesting you speak about flexibility and leverage. I'm just kind of curious. Do you see advantages, in terms of inherently within a strategy, allowing some flexibility in the level of leverage that's taken overtime, that is, explicitly designing capability to increase or decrease the amount of short extension?

And I guess a related question would be, you know, it's always interesting talking with allocators about doing something new. What's the appetite like from from clients on things like that? Yeah. So as you think about, how you implement an extension strategy, you know, first of all, you think about long only you've got this fixed constraint on leverage at zero 130, 30 also has a fixed constraint on leverage.

Just happens to be a plus or -30%. And there's another way of thinking about this would be to say, okay, look, if I have a particular limit on the amount of leverage that I'm willing to take, which is a rational thing to do, it certainly is going to be something that many allocators are going to be sensitive to.

To your point, as they talk to their governance structures and so on and so forth. While you may want to impose that maximum cap on leverage that you take in the portfolio, but you always want to have your portfolio fixed at that maximum level of leverage, and it's not obvious that you do. So one thing that we've done in our higher leverage strategies is, we actually allow leverage to float a little bit.

Certainly we cap it, for example, at one 6060, but we allow some dynamics and basically what allowing that dynamism and leverage does is it gives you the ability to use leverage as a natural shock absorber when volatility, when the market risk environment fluctuates, or when other issues that affect the trade off between active risk and active return trade offs.

So, it's kind of an intuitive concept by allowing, the, amount of leverage that you take to adjust depending on what the market risk environment looks like, you're introducing the shock absorber. You're more fully using this extra parameter, this extra design feature that you have in portfolio construction, in effect, to stabilize performance over time. And it turns out that you can achieve more stability in the information ratios in terms of this trade off between active return and active risk.

That you are taking if you allow this match, this natural shock absorber, to behave, in portfolio construction. Now, in terms of how asset allocators have responded, you know, not only to one, not only to dynamism, to leverage, but also to, say, expanding leverage to go up to 160, 60 versus 130, 30. I would say that given the maturity of these strategies, in some sense, they were introduced almost 20 years ago, and yesterday was a hibernation for an extended period of time.

But there's more, I think, of an acceptance now, in terms of thinking about, higher levels of leverage. And I think it's connected to the appreciation of what allowing higher leverage actually does, that you're not just going out there and saying, I'm going to blindly take on more, increase my active risk target. If I increase leverage, I'm actually going to utilize these design choices in this very deliberate way, as you were discussing, in order to craft a portfolio solution.

That's really connected to the needs that, that I have. So we're seeing greater acceptance of, not just extensions, but also of, this more deliberate utilization of the parameters of the extension strategy, in portfolio construction. I think that's a really healthy thing. That's interesting. Maybe just kind of reflecting on all this, I think anyone who's been around the block for a while knows that it's important to be, you know, skeptical or at least, you know, bring some critical thinking to what we're talking about and just, you know, be a little bit, you know, aware that there are very rarely free lunches in markets.

What are the downsides or challenges in implementing something like this? What do allocators and managers need to be aware of? Yeah, certainly from a from a mechanical perspective, if you will, allocators should be thinking about, what it means to take on short positions in a portfolio. Starting to take short positions in a portfolio is not a trivial decision, for managers that don't have experience managing short positions.

There is certainly a high degree of skepticism, that allocators should bring to the conversation as we think about what that means. Certainly risk management and cost management both come into play. It can be very expensive to take on, short positions. The costs of taking on short positions can vary, quite a bit over time.

And certainly there are downsides in terms of risk exposures that you may wander into, that are associated with the short positions or that may be more pronounced with respect to the shortpositions. And certainly there is risk. Squeezes. And so one of the things that you keep in mind is making sure that you have a high degree of breadth in the short book that you're cognizant, borrowing costs as you're implementing, you're also cognizant and cognizant of how much effectively liquidity are you assuming in, taking those short positions?

And you may very well likely want to have different types of restrictions on the amount of liquidity that you consume or that you're banking on with respect to those short positions versus what you have in the long, in the long side of the portfolio. It can be a very asymmetric sort of perspective of the risks. On the short side versus the long side of the portfolio.

So those types of mechanical considerations, if you will, they're very, very important. What that I think means is that you need a sophisticated portfolio construction, framework, a regimented portfolio construction framework. And I think that's something that systematic managers are very, well, naturally, set up to have, and it's something that you really want to look for in, the extension strategies.

I think there are a few other things, though, that slip a little bit below the radar. In some cases, one of them is that, as we think about this notion that one of the advantages of an extension strategy is that you're not necessarily asking the manager to do something new. From a forecasting perspective, what you should have is a wide range of forecasts that you can naturally exploit.

And you're saying, okay, my long only portfolio is really constraining my ability to express these views. Well, that's sort of predicated on a few different things. One of them is that the manager actually has the ability to generate alpha. What you're saying is you're starting from a long only portfolio where you've got a particular ratio of the amount of, market risk that you're taking versus the risk of exposure to the manager's alpha model.

And the appeal, the whole appeal of the essential strategy is that you want to increase some leverage, allow some leverage so that you can increase that ratio of exposure to the manager's alpha relative to the amount of market exposure that you're taking. But if you don't have confidence in the manager's ability to generate alpha to begin with, that's probably not a wise decision, to, take on.

Second of all, you certainly have to believe that the manager has the ability to express this wide perspective of positive and really negative views across a broad investment universe. If you have, for example, a discretionary manager who's used to just picking a few high, expected high fliers, if you will, in a portfolio, I wouldn't think that that's a naturally conducive, sort of approach to creating an extensive strategy, because you have to invent the set of other views, more negative views, that, the manager, is expressing.

So it's not just a matter of unlocking flexibility. Now you're asking the manager to change how they do forecasting. And then finally, I would say that again, as we talk about, this notion of using the full flexibility of extension strategies, we talk about capping leverage and, you know, potentially using leverage as a way to change how you take tracking error relative to active exposure.

You want to have some confidence that the manager has something special. It has the ability to generate alpha from idiosyncratic positioning, if you will, that they're not just going to wind up, generating excess returns by latching on to a handful of systematic risk factors, if you will. You want the manager to have more flexibility, that can be allowed in portfolio construction in order to really unlock the benefits of, the flexibility of leverage.

That's interesting. Okay. So I think maybe coming full circle, I'm not going to ask you to, you know, pick the best, you know, version of implementing a short extension strategy, because I think, as you said, there's a lot of nuances in terms of market conditions and also investor goals. But how would you kind of sum up our discussion if you're trying to help allocators understand how all these parts of, you know, investing that is returned, forecasting portfolio construction and risk and leverage, how do they all work together to achieve better results?

So I'll just let you sum that up for us. You know, I think, in a nutshell, what I would say is that we've traditionally thought or a lot of allocators traditionally think, of the trade offs between expected return and expected risk in portfolio construction. But underneath, that, sort of viewpoint is this assumption that leverage is fixed and it's fixed at zero.

What we're thinking is that as we evolve, as markets evolve, it's actually better to think about leverage as a design choice. It's not one that should be taken lightly. It's one that should be thought out very deliberately relative to the needs, and the views that, allocators have. But there's much more. They're much, better portfolios that we may be able to construct.

For asset allocators to map to those views. If we allow ourselves flexibility to think of leverage as an independent design choice, in much the same way that we think about expected return, unexpected risk. Okay. Thank you so much. That was very insightful. And thank you also to everyone for joining us today.