Capturing Systematic Fundamental Alpha to Build an Equity Enhancement Strategy

What is an equity enhancement strategy?

An equity enhancement strategy aims to achieve higher total returns than a benchmark without increasing overall market risk. Such portfolios include securities expected to perform well in long positions while shorting those expected to underperform. Proceeds from shorting can be used to increase long positions or strengthen conviction in existing holdings, creating an "enhancement" effect over a 100% long-only exposure. For example, capital from a 50% short position can be invested in longs, building a 150% long position.

Why institutional investors favor enhancement strategies

Equity enhancement strategies allow investors to actively position both positive and negative stock-specific views, rather than being limited to relative overweight and underweight positions within a traditional long-only framework, thereby helping to improve portfolio efficiency. If implemented prudently, such strategies can allow stock selection to play a greater role in driving returns without significantly changing the overall risk profile of the portfolio.

Potential advantages of equity enhancement strategies may include:

• Improved risk-adjusted returns due to more flexible investment in both long alpha and short alpha views.
• 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.

Evolution of enhancement strategies

Equity enhancement strategies focused on quantitative investment processes gained popularity in the early 2000s. Recently, improvements in data availability, portfolio construction, and risk management have led to more targeted implementations, increasing investor interest in strategies that emphasize stock-specific insights rather than traditional factor bets and industry exposure.

Why we believe the Fidelity Fusion Alpha strategy is different

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—both long and short—rather than relying on factor bets or style tilts. A Fidelity white paper titled "Unlocking Alpha" details how the Fidelity Quantitative Research and Investment (QRI) team generates and uses these signals.

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

1. Fidelity analyst research:Utilizes internal analyst ratings, earnings estimates, research reports, target prices, and model portfolios.
2. Portfolio manager data:The Fidelity QRI team tracks and generates signals based on active weights of funds relative to their 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.

How the portfolio is constructed

The strategy typically employs a 150/50 structure. Proportions can be adjusted, but the common target is to use 50% short exposure to finance 150% long exposure, with net exposure near 100%. Short positions are selected using the same framework as longs, being an integral part of the return-seeking process rather than a byproduct of risk management. QRI testing shows that 150/50 is the optimal portfolio structure for this alpha model, maximizing the contribution of uncorrelated alpha signals.

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

What makes Fidelity's equity enhancement strategy unique

Fidelity's strategy has five characteristics: 1) Systematic; 2) Fundamentally driven; 3) Scalable; 4) Differentiated; 5) Able to generate returns from idiosyncratic risk.

Breaking it down...

1. SystematicMeans the strategy is process-driven, without any subjective changes by management. It is a systematic implementation of Fidelity's fundamental intellectual property.
2. Fundamentally drivenRefers to the Fidelity QRI approach using proprietary fundamental data, differing from factor-based quantitative strategies.
3. ScalableMeans the strategy adds value for clients with large portfolios and remains effective as portfolio size grows.
4. DifferentiatedRefers to its benefit from proprietary research methods that are not shared outside Fidelity.
5. CapableOf generating returns from idiosyncratic risk, meaning the strategy aims to concentrate 90% to 95% of risk exposure on 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 uses a systematic approach to manage long and short positions and related risks, including:

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

At Fidelity, our investment approach combines decades of fundamental research, deep talent, and disciplined systematic processes to turn differentiated insights into consistent and 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 changing its role in the portfolio. The strategy is fundamentally driven, systematically managed, scalable, and deliberately avoids unintended factor exposure, making stock selection the primary driver of results.