More room for alpha in concentrated global equity markets

Global equity indices have become increasingly dependent on a relatively small number of mega-cap companies. What does that mean for active investors?

Market concentration itself is no longer a new story. The more interesting question is what it means in practice for portfolio construction.

For a traditional long-only manager, the largest index constituents create a difficult starting point. If you want to invest more in companies elsewhere in the market, you generally need to reduce another position to fund those ideas. That can result in sizeable underweights in the very companies that have become the main drivers of benchmark performance.

The success of the portfolio may then depend not only on the performance of the manager’s preferred stocks, but also on whether the underweights, which are not the result of an intentional position, hinder performance. In this case, the forecasting ability of managers may be masked by limitations in portfolio construction. This can make it difficult to generate meaningful active returns without concentrating risk in a relatively small number of decisions.

How does Global Active Extension approach this challenge differently?

The active extension structure gives us greater freedom to translate our stock forecasts into portfolio positions. In addition to the core global equity portfolio, we can express negative views through a short extension of up to 50% and use the resulting capacity to invest more in companies with attractive return prospects.

This means that a new investment idea does not always have to be financed by reducing exposure to a major benchmark constituent. We can retain broad exposure to the companies that matter to the global market while pursuing additional alpha opportunities across a much wider universe. Highly concentrated markets mean that many shares in the index have an even smaller weighting than they would in normal market conditions. The active extension approach enables us to implement a negative view of a company more effectively in such an environment.

Although the extension of the long-only portfolio increases the active share relative to the benchmark, the portfolio remains beta-neutral relative to the benchmark at all times.

In simple terms, active extension creates more room for stock selection. It allows both positive and negative forecasts to contribute to the portfolio rather than leaving part of the investment insight unused.

Does greater investment freedom also mean taking substantially more risk?

Not in the sense of simply making a few larger bets. The purpose of the extension is to broaden the opportunity set, not to build a concentrated portfolio.

Our investment process combines many individual positions, each of which generally makes a relatively small contribution to the overall result. The Global Active Extension portfolio is expected to hold approximately 700 to 900 stocks. Active risk can therefore be distributed across a large number of investment ideas instead of being dominated by a handful of high-conviction positions.

At the same time, portfolio construction remains benchmark-oriented. We assess expected returns together with risk, liquidity, transaction costs and practical implementation considerations. The objective is to seek additional alpha while retaining the risk characteristics investors expect from a broadly diversified global equity allocation.

Why is a systematic investment process particularly suited to an active-extension strategy?

A broader opportunity set is only valuable if you can evaluate it consistently. Our systematic process enables us to analyse thousands of companies using the same disciplined framework and to compare opportunities across countries, sectors and industries.

This breadth is important. We are not trying to identify the ten or twenty companies on which everything depends. Instead, we aim to combine many modest but attractive stock-level forecasts in a diversified portfolio.

Active extension also enables us to make fuller use of the research. In a conventional long-only portfolio, a negative forecast may simply lead us not to own a stock. Here, that insight can make an active contribution to the portfolio. This expands the number of forecasts that can potentially add value without changing the fundamental character of the allocation.

How is the extension implemented in the strategy?

We use derivatives, specifically a portfolio-swap-based implementation of the active extension feature. This allows us to implement the additional positions efficiently and is designed to reduce the operational and governance complexity associated with physical short-selling.

For investors, however, the internal mechanics should not obscure the investment outcome. The core portfolio provides broad global equity exposure, while the extension creates additional capacity for active stock selection. The two elements work together within one integrated and risk-controlled strategy.

The new Luxembourg SICAV UCITS Quoniam Global Equities fund makes this approach available in a familiar institutional fund structure. Investors gain access to an innovative investment concept without having to establish the operational infrastructure that would normally be associated with managing such positions directly.

What experience does Quoniam bring to this type of investing?

Although the Global Active Extension strategy is new, active extension is not new to Quoniam. We manage more than € 2 billion in European Active Extension strategies and have over 15 years of experience in similar strategies.

Our portfolio management team has also received “Best Fund Manager” recognition for three consecutive years* for the European strategy. But experience is about more than the time a strategy has been running or the awards it has received. It also includes the research, portfolio construction, risk management and implementation capabilities required to manage an extension strategy effectively from day to day.

The new global strategy brings that established expertise to a considerably broader investment universe.

Where could Global Active Extension fit within an investor’s portfolio?

We see it as a potential core global equity allocation for investors who want to seek greater alpha potential while retaining diversified exposure to global equity markets.

Investors do not necessarily have to choose between participating in the companies that dominate the benchmark and finding return opportunities elsewhere. By creating additional capacity for active stock selection, Global Active Extension is designed to do both: maintain broad market exposure while drawing on a much wider range of investment insights.

That, for us, is the central idea behind the strategy—and why active extension is especially relevant in today’s global equity market.

* Awarded by Handelsblatt Research Institute.