In conversation: Wellington Management on sourcing alpha amid market concentration
The impacts of tariffs and other US policy changes on stock markets and macro dynamics require equities investors to identify reliable ways to generate returns beyond their respective benchmarks.
This is challenging given risks such as concentrated markets. For example, with the ‘Magnificent 7’ accounting for around a quarter of the MSCI World Index, and roughly a third of this Index in IT and communications services companies (as of end-December 2024), active managers might struggle to differentiate portfolios and outperform.
This creates a compelling opportunity for Wellington’s extension strategies. “We believe this allows us to generate more consistent alpha through bottom-up stock selection,” said Li.
Flexibility to express investors’ views
The edge that extension strategies can offer versus a traditional long-only approach, especially against today’s market backdrop, is giving fundamental stock pickers additional flexibility to outperform a benchmark. “That's become more crucial in an environment where benchmarks have become more concentrated,” added Baldini.
With benchmark relative strategies, he explained that half of the risk comes from the stocks that a manager overweights, while the other half is from those the manager underweights. Yet greater concentration means the potential to underweight stocks also becomes more concentrated in the largest names – and therefore the opportunity to contribute to returns is marginal.
According to Baldini, an extension portfolio allows a manager the flexibility to use shorts to underweight any stock in the benchmark, and by however much they want. They can even underweight stocks that aren't in the benchmark.
“Having the ability to short allows us to also express negative views on companies with poorer fundamental,” added Li.
Leveraging expertise
In Baldini’s view, executing a successful extension strategy relies on three key factors.
Firstly, it needs talent across sectors. At Wellington, close to 60 global industry analysts cover industries around the world, and from large cap to small cap companies (as of end-March 2025). “We have lots of different alpha sources,” said Baldini.
Secondly, Wellington has the required track record of long/short investing based on the experience of its hedge fund business, which started in the mid-1990s and has since expanded across multiple sectors.
Finally, risk management is critical with any long/short portfolio. And with a large, dedicated team at Wellington to conduct manager research, allocate capital and manage risk, Baldini said it is possible to achieve a profile for the extension strategy of low tracking risk – a high percentage of which is idiosyncratic – in a highly active portfolio designed to outperform a benchmark.
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