Understanding Active Extension

What is Active Extension?

Active Extension ("AE") builds on traditional equity investing by adding modest flexibility through long and short positions. In a typical long-only portfolio, an asset manager can only buy stocks. If they expect a company to underperform, the most they can do is avoid owning it.

Active Extension allows managers to take both long and short positions. The proceeds from short positions in companies expected to lag can be used to fund larger positions in companies  expected to outperform.

The overall portfolio remains fully invested in equities, with total market exposure similar to a traditional stock portfolio.

 

Illustrative "140/40" Portfolio

 

Source: AQR. For illustrative purposes only and not representative of a portfolio AQR currently manages. A short position is a trading position in which a trader borrows and sells shares of a security, hoping its price will fall, so the shares can later be repurchased at a lower price for a profit.

 

Moving Beyond Long-Only

In long-only portfolios, portfolio construction—like that of any live investment portfolio—involves tradeoffs.

For long-only constrained investing, increasing exposure to stocks expected to outperform often requires reducing exposure elsewhere, including in companies a manager may still view positively.

At the same time, if a stock represents a small portion of the index, choosing not to own it has limited impact. This can make it difficult to benefit from identifying weaker companies.

Active Extension removes these constraints. By allowing both long and short positions, the implemented portfolio better reflects the manager's positive and negative stock views.

 

Illustrative Long-Only and Active Extension Positive/Negative Stock Views

 

Source: AQR. For illustrative purposes only and not representative of a portfolio AQR currently manages.

 

Getting Comfortable with Leverage

Active Extension includes both long and short positions, which introduces what is known as gross leverage—but importantly, not net leverage. The portfolio still maintains 100% market exposure.

Leverage has the potential to increase risk if not managed carefully. For this reason, experienced managers typically apply disciplined risk controls, including:

  • Managing Volatility: Targeting a pre-defined range of portfolio volatility
  • Exposure Limits: Employing sensible constraints to manage individual stock and factor risks
  • Liquidity Focus: Investing in securities that can be traded efficiently
  • Stress Testing: Evaluating how the portfolio may perform under adverse conditions
  • Dynamic Oversight: Continuously reassessing portfolio risks and exposures

For investors who believe in active management, Active Extension represents an evolution of traditional equity investing.

 

Related Funds

 

DISCLOSURES

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There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially and should not be relied upon as such.

View definitions of benchmarks and other terms used here.

The investment strategy and themes discussed herein may not be in the best interest of investors depending on their specific investment objectives and financial situation.

Diversification does not eliminate the risk of experiencing investment losses. There is a risk of substantial loss associated with trading commodities, futures, options, derivatives and other financial instruments. Before trading, investors should carefully consider their financial position and risk tolerance to determine if the proposed trading style is appropriate. Investors should realize that when trading futures, commodities, options, derivatives and other financial instruments one could lose the full balance of their account. It is also possible to lose more than the initial deposit when trading derivatives or using leverage. All funds committed to such a trading strategy should be purely risk capital.

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