The Core Plus Trilogy

October 2013 

“Core Plus” often refers to the introduction of high yield and international fixed investments to an otherwise high quality domestic fixed income fund. Dissatisfied with low yields and meager total returns, investors expand their policy statements in an effort to capture alpha in a broader set of opportunities. This “broader mandate” recognizes the mathematical reality that the return potential in a narrowly defined universe is limited, and that active management is handcuffed in its attempt to capture alpha by a limited mandate.

The Convergence Core Plus Strategy applies this concept to the domestic equity market. Armed with a broader universe to seek out attractive investments, and an expanded set of tools, the Core Plus Strategy is built to seek out alpha from multiple sources. The concept of “multiple alpha sources” is an extension of basic portfolio theory. If you are able to diversify your assets, you anticipate that your return pattern will be more consistent. Asset diversification is decision diversification. By building an allocation, the portfolio manager is making multiple decisions on the value and return potential of different asset groups. Our approach looks to diversify the decision process across multiple sources such that if any one decision proves untimely, we rely on other decisions within the portfolio to in effect, cover.

The Trilogy is a set of three papers that build out the research that is the basis for the Core Plus Strategy. Researched over eight years, the Core Plus Strategy today employs a dynamic quantitative model that actively measures preference shifts in investor behavior, and then seeks out “attractive” equity investments that incorporate those preferences. Further, the Strategy taps an important and complementary source of alpha in the form of an active short imbedded within the existing long strategy.

A New Model for Improving Returns

This is the first of the three papers, and is the genesis of our Strategy. We explore how correlations within the equity market have risen over the years, and observe its debilitating impact on traditional active management as well as the traditional asset allocation approach. We examine how dispersion of return is critical to generating alpha and seek out where dispersion still exists. Research is presented that examines how investors exhibit strong preferences for certain characteristics at a point and time in the cycle. These preferences simply reflect the characteristics that investors believe have the highest probability of prevailing in an uncertain environment. The conclusion is that rather than diversifying away the effects of these shifts as the traditional model seeks to do, we seek to measure them, and allow the portfolio to adjust through the cycle.

The Persistency of Preferences

The Convergence model measures how preferences for certain characteristics change as the market cycle progresses. Our research found that the traditional method of dividing equities into growth versus value, and large versus small was insufficient to explain stock price behavior. Instead, we found that we could explain price movement across 24 industry groups using 13 preferences. The question remained, however, to be effective, wouldn’t the model either have to anticipate preference changes, or would it have to rely on preferences being relatively stable and persistent? In the second paper, we explore the history of preference shifts and examine whether the changes are sufficiently long in duration as to be measurable and exploitable. We conclude that while all preferences do not apply to every industry group, and all are not stable and persistent at all times, there are in fact many long duration trends that last for years, and persist even through short term market reversals and spikes in volatility. Further we found that it is not necessary to catch the inflection point in order to capture the return potential.

The Structural Impact on Alpha

In this final paper in the Trilogy, we examine the real time impact provided by the active short position within the portfolio. We examine how our implicit long/short portfolio has performed. We review the long/short portfolio’s role within the overall portfolio, and its impact on the risk/return of the total portfolio. We examine the cost implications of adding this extra source of alpha to the portfolio, and demonstrate the efficiency of the broader Core Plus Structure.


These three papers build on each other. Each explores a body of research that we conducted in our pursuit of a more effective method of capturing the return potential of the equity market.

About Convergence Investment Partners

Convergence Investment Partners uses quantitative tools to select investments, construct portfolios and manage risk for individuals, businesses, financial advisors and institutional investors. The team applies proprietary investment strategies, supported by extensive research, with a goal of generating alpha across various stages of the market cycle.

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