(Bloomberg) -- It hearkens back to a go-go era that Wall Street might want to forget. Yet that’s not stopping AQR Capital Management, Man Group and Acadian Asset Management from selling with renewed zeal a breed of leveraged product that fell into ill repute after the global financial crisis.
With many of their clients struggling to beat a runaway stock bull market, the systematic money managers are back touting the virtues of using borrowed money to wring out extra returns across traditional indexes of stocks and bonds.
Acadian and Man Group are pushing alternative trades known as equity extensions that offer steady exposure to a stock benchmark, but juiced up with leverage to finance long and short positions. Similarly, AQR is gearing up products based on “portable alpha,” deploying borrowed cash to layer active wagers on top of a passive-allocation process.
While the details differ, the strategies come with a scientific ring, promising that leverage — deployed judiciously — can squeeze precious percentage points of gains out of vanilla portfolios, with only a modicum of risk.
The pitch isn’t new. These investing styles both boomed until the 2008-era fallout, when their diversification value proved illusory as a slew of assets sold off in tandem. But as stretched equity valuations stoke angst about potentially below-average returns ahead, these amped-up strategies are now finding an uptick in demand from institutional investors battling to meet return targets and prove their worth.
“There’s a whole host of factors that suggest this is something that people really should be taking seriously,” said Peter Hecht, head of the North America portfolio solutions group at AQR. “We think the potential is huge.”
After years of hemorrhaging money, interest is perking up. US funds focused on equity extensions drew the most inflows since 2009 in the second quarter, the latest Nasdaq eVestment data show. Acadian says it anticipates more than $1 billion flowing into its extension strategies in the coming months, adding to the $1.5 billion it currently runs.
This year, AQR has been rolling out its most comprehensive version of the portable-alpha trade yet, including offerings that help reduce potential execution risks. In total, these latest allocation programs currently hold $375 million in assets, with “a few hundred million” dollars in the pipeline, according to people familiar with the matter, who asked not to be identified discussing private information.
By using borrowed money, these kind of strategies are meant to boost returns, in case the broad market starts to sag — as long as their stock-picking model makes money, of course. The push comes as technology megacaps like Apple Inc. have propelled US stocks to a decade-long rally, surpassing almost every other asset and leaving an overwhelming number of active investors in the dust. The S&P 500 climbed higher Wednesday as the US posted solid economic growth and Alphabet Inc. reported better-than-expected sales.
“If you just sell an alternative strategy today, it’s so hard to get anybody to care because the S&P is up 23%,” said Eric Balchunas, senior ETF analyst with Bloomberg Intelligence. “So what they’re saying is, ‘Hey, you don’t have to get rid of your beta. Keep your beta. Let’s just add on the alternative using this portable alpha strategy.’ So it’s kind of like, have your cake and eat it too.”
Acknowledging the market is hard to beat, advocates say portable alpha allows investors to spread out bets without sacrificing the market return, or beta. That’s because the allocation method uses derivatives to match an index’s performance with less cash on the table. It then invests the rest of the capital in something that adds value, or alpha, such as trend following or market-neutral wagers.
“It’s just become really, really, really tough to beat the US market with the Mag Seven in play,” said Zhe Shen, head of diversifying strategies at TIFF Investment Management, which has added to these offerings lately. “With a portable alpha strategy, you’re on even starting ground because you have the beta.”
Diversified allocation processes may look particularly smart in the event that big-name equity indexes struggle to post outsize gains in the years to come. Strategists at Goldman Sachs Group Inc. projected this month the S&P 500 will gain just about 3% annually for the next decade, compared with 13% over the past period.
More broadly, the relentless tech-driven equity rally in recent years has sparked a broader debate about whether traditional retirement portfolios are the right choice for long-term investors. Last year, three researchers claimed that a devotion to bonds had cost American retirees trillions of dollars in lost profits over the last century. Their paper drew rebuttal from AQR co-founder Cliff Asness, who has argued that adding a dash of leverage to amp up a diversified portfolio can be less risky — and just as attractive as only piling into stocks.
Theory to Practice
Portable alpha is seen as a way to put that theory in practice. Since the start of 2023, Newfound Research and ReSolve Asset Management have launched a handful of exchange-traded funds with the idea rebranded as “return stacking.” Those funds have collected about $800 million in assets.
In contrast, equity extensions look more like long-only funds — think hedge funds-lite. Many are known as 130/30, which means that for every $100 invested, you get $130 of long positions and $30 of short positions, resulting in the same $100 net exposure to a stock index.
Theoretically, those extra bets help free the stock picker from the benchmark’s stranglehold, giving more influence to positions that might otherwise be drowned out by the bigger constituents. About 85% of the global MSCI ACWI index’s members have a weighting of five basis points or less, an increase over the past decade, Man Group calculated in a note touting the strategy. That doesn’t leave much room to be bearish in a long-only setup.
By employing the 130/30 approach, a manager can get basic exposure to the index, while extra money is freed up to put on more positions, go bigger on a beloved name or outright short a stock.
“In an environment where many managers have struggled with their active strategies, this is a comparative bright spot,” said Ryan Taliaferro, director of investment strategies at Acadian, whose global extensions strategy has posted a five-year annualized return of 23.2%.
The likes of 130/30 are also booming in retail investment accounts, where they are pitched as tax-efficient strategies that can generate more capital losses in individual positions than long-only approaches.
Even then, extensions are no sure-fire win. The average return in the category has beaten the S&P 500 in just two of the last five years, eVestment data show. It was slightly behind in the first half of 2024.
And of course, both extensions and portable alpha famously misfired in the grip of the financial crisis, as concerted losses across assets and vanishing liquidity thrashed pension funds and endowments that had piled into the levered trades.
Still, AQR says it has found a way to make the strategy more transparent and less risky. Rather than offering just the alpha portion as it was typically done in the old days, AQR now lets clients pick their desired beta and alpha holdings, without the hassle of opening a margin account. In other words, the Greenwich, Connecticut-based manager oversees the broad package, from running the beta and the alpha side of the portfolio, to cash management and performance reporting.
“Compared to earlier versions of portable alpha, the complexity risk is largely off the table,” Hecht said.
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