Active-extension strategies have been a key innovation in the fund management industry, offering investors greater flexibility and enhanced potential for returns. J.P. Morgan Asset Management has extensive experience in this area, with offerings focused on the U.S., emerging markets, UK and Europe. For over 20 years, we have delivered strong results to clients worldwide.
Below, we outline the case for active-extension funds and the distinct advantages they offer versus traditional long-only approaches, including:
- The ability to generate additional alpha through short positions
- Access to a broader range of investment opportunities
- Higher active share and diversification
- More effective risk allocation
We believe the active-extension approach offers a more efficient way to invest. By incorporating short positions, we can access a wider range of alpha opportunities while maintaining the same net market exposure as a traditional long-only portfolio. This flexibility allows us to fully leverage our global research platform, allowing us to act on both positive and negative insights. As a result, we can unlock additional sources of alpha and allocate more capital to our highest conviction ideas, across both long and short positions.
What is an active-extension fund?
A typical active-extension equity portfolio has a gross long exposure greater than 100%, which is partially financed by short exposure. While the 130/30 structure, 130% long and 30% short, resulting in 160% gross exposure and 100% net long exposure, is common, portfolios can also be constructed with other ratios, such as 140/40 or 150/50. In each case, the net market exposure remains comparable to that of a traditional long-only fund, so performance should be evaluated against standard equity benchmarks. These funds are suitable for inclusion within an equity allocation.
Active-extension funds differ from equity long-short hedge funds in three key ways:
- Net market exposure: Active-extension funds maintain a net long exposure similar to long-only funds.
- Benchmark focus: Their returns are measured relative to an equity benchmark.
- Liquidity: They typically offer daily liquidity.
Why are extension strategies relevant today?
Long-only investing is the dominant approach within the equity market, meaning short selling is not always considered by investors. This constraint is significant because it limits portfolios to profiting primarily from rising stock prices, while reducing their ability to benefit from declines, express negative views on overvalued securities, manage downside risk and potentially enhance returns.
Capitalization-weighted equity benchmarks are heavily skewed toward the largest companies. For example, exhibit 2 illustrates the distribution of weights across several global indices. In the MSCI Emerging Markets Index, most stocks have very small index weights; only seven stocks have a weight greater than 1%. This skewed distribution limits long-only portfolios’ ability to express negative views on the majority of the 1,126 securities in the emerging markets investment universe. Figures are similar for the S&P 500 and other indices globally.
J.P. Morgan Asset Management’s capabilities
Quantitative and fundamental research is the backbone of how we invest. With over 20 years of global experience managing active-extension portfolios, we leverage our comprehensive research platform to implement a wider range of investment ideas and enhance portfolio construction. We rank stocks from most attractive (Q1) to least attractive (Q5), ensuring we have a clear view on every company under coverage.
The active-extension advantage
Active-extension strategies provide managers with the ability to generate additional alpha by incorporating short positions. By relaxing the long-only constraint, the investment opportunity set expands significantly, allowing for greater flexibility in portfolio construction. This structure enables managers to more effectively express their views, both positive and negative, and allocate active weight to their highest conviction ideas. As a result, investors can achieve a more efficient use of capital and benefit from enhanced return potential. When paired with a robust investment process, active-extension portfolios offer a valuable approach to equity investing.