Flexibility, Transparency and Cost Efficiency
We think a data-driven, low‑alpha framework offers significant flexibility and transparency without compromising cost discipline. Its key advantages over purely passive approaches include the ability to deliver a customized portfolio aligned to specific objectives. An investor’s preferences can be integrated by defining the portfolio’s investable universe, setting the level of tracking error in line with the investor’s risk tolerance, customizing the alpha drivers to align with the investor’s return goals, and introducing value-based investing criteria such as sustainability goals.
In addition to integrating investor preferences, Alpha Enhanced strategies provide the transparency needed to monitor their impact on risks and returns across financial and non-financial components. This creates a feedback loop that can help guide the evolution of non-financial goals as internal and external policies change over time. We believe this level of granularity in attribution is best supported by a bottom‑up, systematic approach.
The costs associated with alpha enhancing also tend to be lower than those of traditional active strategies. Expense ratios are typically slightly higher than for passive funds, but this can be offset by the potential to generate alpha, which is not available to passive portfolios. For investors open to performance‑based fee structures, base fees for Alpha Enhanced strategies can be comparable to passive, with additional fees paid only on excess returns through performance participation, potentially allowing performance to pay for itself. The high alpha efficiency typical of low-tracking-error strategies translate to lower marginal costs at lower risk levels, while a scalable, systematic alpha engine helps keep operational costs contained, in our view.
Enhancing with Alpha: A Balance Between Active and Passive
An Alpha Enhanced approach strikes a balance between active and passive investing that can benefit investors, in our view. Like passive strategies, Alpha Enhanced strategies limit tracking error by sticking close to a reference benchmark; like active strategies, they offer professional risk management and the potential to outperform the market. By pursuing alpha stability, efficiency, and balancing risk, Alpha Enhanced strategies can potentially help investors achieve their goals related to risk and return, sustainability and cost.
We think a systematic, data-driven approach is essential for Alpha Enhanced strategies that seek to generate consistent outperformance while building and calibrating a portfolio within the risk limits set by the investor. This approach has the required scale and coverage to seek to smooth out the excess return profile by making a large number of small active bets along the entire benchmark, while maintaining control over any unintended biases. A robust alpha and portfolio construction engine, backed by an experienced management team, appropriate infrastructure, data, technology, and continuous research are instrumental to success, in our view.
1Goldman Sachs Global Investment Research. As of October 18, 2024. In a global strategy paper, Goldman Sachs analysts forecast that the S&P 500 would generate a 3% annualized nominal total return through 2034.
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