Systematic Fundamental Alpha Capture: Paths and Practices for Building Equity Enhancement Strategies

What is an equity enhancement strategy?

An equity enhancement strategy aims to achieve total returns that exceed a benchmark without increasing overall market risk. Such portfolios typically hold both long and short positions: securities expected to perform well are included in the long book, while those expected to underperform are sold short. Proceeds from short sales can be used to add more long positions or strengthen conviction in existing holdings, creating an "enhancement" over a 100% long-only exposure. For example, the proceeds from a 50% short position can be invested in longs to build a 150% long book.

Why institutional investors favor enhancement strategies

Equity enhancement strategies improve portfolio efficiency by allowing both positive and negative active investments in individual stocks, rather than relying solely on relative overweight and underweight positions within a traditional long-only framework. When implemented prudently, such strategies allow stock selection to play a greater role in driving returns without significantly altering the portfolio's overall risk profile.

Potential advantages of equity enhancement strategies may include:

• The potential for better risk-adjusted returns due to the flexibility to invest in both long alpha and short alpha ideas.
• The ability to generate alpha in both rising and falling markets.
• Improved portfolio efficiency compared to traditional long-only portfolios, partly due to freedom from benchmark tracking and portfolio construction constraints.

The evolution of enhancement strategies

Equity enhancement strategies focused on quantitative investment processes gained popularity in the early 21st century. In recent years, advances in data availability, portfolio construction, and risk management techniques have driven more targeted implementations, increasing investor interest in strategies that emphasize individual stock insights and eschew traditional factor bets and industry exposure reliance.

We believe the Fidelity Fusion Alpha strategy is differentiated

The Fidelity Fusion Alpha equity enhancement strategy systematically captures stock-level insights from Fidelity's fundamental research analysts, portfolio managers, and alternative data. The strategy focuses on identifying and investing in idiosyncratic return opportunities—long or short—rather than relying on factor bets or style tilts. A white paper published by Fidelity titled "Unlocking Alpha" details how the Fidelity Quantitative Research and Investment (QRI) team generates and utilizes these signals.

The Fidelity Fusion Alpha equity enhancement strategy relies on three types of differentiated data

1. Fidelity analyst research:Utilizes internal analyst ratings, forecasts, research notes, target prices, and model portfolios.
2. Portfolio manager data:The Fidelity QRI team tracks and generates active fund weight signals relative to various benchmarks, covering approximately 85% of tradable stocks.
3. Alternative data:Long-term growth and earnings forecasts, point-of-sale data, geolocation data, etc., used to predict company key performance indicators.

Portfolio construction approach

The strategy typically employs a 150/50 structure. The ratio can be adjusted, but the common target is 150% long exposure financed by 50% short exposure, with net exposure near 100%. Short positions are selected based on the same framework as longs and are an integral part of the return-seeking process, not a byproduct of risk management. QRI testing indicates that the 150/50 structure is the optimal portfolio for this alpha model, maximizing the use of uncorrelated alpha signals.

The portfolio targets an information ratio greater than 1, seeking to derive excess returns from idiosyncratic risk rather than factor bets. This is crucial because, as noted earlier, higher exposure to market factors introduces greater sources of hidden volatility. Unexpected exposures to specific factors (mid-cap, value, growth momentum, etc.) can erode portfolio performance and, if uncontrolled, may cause the portfolio to deviate from its stated risk parameters and return objectives.

What makes Fidelity's equity enhancement strategy unique

Fidelity's strategy is: 1) systematic, 2) fundamentally driven, 3) scalable, 4) differentiated, and 5) capable of generating returns from idiosyncratic risk.

Let's break it down...

1. Systematicmeans the strategy is process-driven and does not include subjective management changes. It is a systematic implementation of Fidelity's fundamental intellectual property.
2. Fundamentally drivenmeans the Fidelity QRI approach utilizes proprietary fundamental data, unlike factor-based quantitative strategies.
3. Scalablemeans the strategy adds value for clients with large-scale portfolios and remains effective as portfolio size grows.
4. Differentiatedmeans it benefits from a proprietary research methodology that is not shared outside Fidelity.
5. Capableof generating returns from idiosyncratic risk means the goal is to allocate 90% to 95% of risk to idiosyncratic or stock-specific sources.

What the Fidelity Fusion Alpha equity enhancement strategy can offer investors

The strategy can complement or replace core equity allocations, seeking incremental return potential without changing overall equity exposure.

How leverage and shorting work in Fidelity's strategy

The QRI team employs a systematic approach to managing long and short positions and associated risks, including:

• Integrating oversight and risk management into every stage of the investment process (alpha modeling, optimization, portfolio construction, trading, etc.).
• Understanding that shorting changes risk relationships and differs from underweighting relative to a benchmark. Shorting requires robust short-selling infrastructure and rigorous oversight, which the QRI team possesses.
• Focusing on concentration risk and benchmark freedom relative to long-only portfolios, recognizing that a 150/50 strategy can offer greater diversification.

At Fidelity, our investment approach reflects decades of fundamental research, deep talent, and a rigorous systematic process, striving to convert differentiated insights into consistent, repeatable performance.

By focusing on idiosyncratic return sources and prudently managing leverage and short exposure, the Fidelity Fusion Alpha equity enhancement strategy can help clients extract more potential return from core equity exposure without altering its role in the portfolio. The strategy is fundamentally driven, systematically managed, scalable, and deliberately avoids unintended factor exposures, making stock selection the primary driver of outcomes.