At first glance, long-only active U.S. equity portfolios may not appear to fit the traditional definition of return stacking, which is typically associated with explicitly layering multiple independent return streams. However, when examined through a different lens, these strategies already contain two distinct sources of return: broad market beta and an active long/short tilt relative to the benchmark.

To illustrate this, consider an active large-cap equity fund benchmarked to the S&P 500. The fund manager’s goal is to generate alpha by overweighting stocks expected to outperform and underweighting those expected to underperform. For example, if the S&P 500 allocates 7% to Apple and the manager believes Apple will lag, they may reduce their Apple allocation to 3%. This implicit underweight functions as a short position relative to the benchmark – even though the manager does not technically short the stock.

Simultaneously, if the manager increases their exposure to an underappreciated stock, such as a smaller industrial firm at 1% versus the benchmark’s 0.3%, this overweight effectively acts as a leveraged long position compared to the index. The result is a portfolio that combines market beta with a dollar-neutral long/short overlay – just like an explicit return-stacking approach, but constrained by the structural limits of a long-only framework. Unlike explicit return-stacking portfolios, where managers can access uncorrelated return sources (such as managed futures or bonds), long-only active managers must extract alpha strictly from large-cap U.S. equities. This raises an important question for advisors: Is this the most efficient way to achieve diversified return sources?

The effectiveness of diversification depends on an investor’s ability to hold onto diversifiers through all market environments. Many alternative strategies, such as hedge funds or private equity, experience capital outflows during underperformance cycles due to investor impatience and behavioral biases. However, managed futures have consistently demonstrated long-term resilience, offering investors a return stream that does not rely on equity market direction.

A key benefit of return stacking is that investors do not have to sacrifice their equity exposure to introduce diversifiers. This removes a common psychological hurdle – investors do not feel like they are “missing out” during equity bull markets, making them more likely to maintain managed futures exposure over time.

Advisors who implement return-stacked strategies reduce the likelihood of clients abandoning diversification at precisely the wrong time, helping investors benefit from a more stable investment experience over time.

One challenge is that the size of the active long/short overlay is constrained. Most active funds stay within a narrow tracking error to their benchmark, meaning the long/short component is relatively small. Managers can’t dramatically overweight or underweight positions without taking on substantial benchmark-relative risk. This limitation makes it difficult to generate significant excess returns without potentially making large, unintended bets – such as sector overweights that may dominate stock selection effects.

Now contrast this with Embecta Corporation, the smallest company in the S&P 500. If Embecta comprises just 0.01% of the index, the most an active manager can underweight it is also to 0%, but the short position is only 0.01% of the benchmark. This means that avoiding a large stock like Apple has a much greater impact on relative performance than avoiding a small stock like Embecta.

In contrast, an explicit long/short strategy allows managers to take more meaningful short positions, regardless of index weightings. This makes it difficult for long-only managers to fully express their negative views on large stocks without substantial tracking error, while small-cap stocks barely register in their active positioning.

In today’s market, where a handful of mega-cap stocks – Apple, Microsoft, Amazon, Nvidia, Google, Tesla, and Meta – dominate the S&P 500, achieving high active share without taking massive, concentrated bets is difficult. The sheer size of these companies means that underweighting them meaningfully often results in substantial index tracking error. Managers who try to maintain high active share while controlling risk often find themselves forced into mid-cap or small-cap tilts, diluting their core strategy and introducing additional style risk.

Another major drawback is that active managers in large-cap U.S. equities are confined to seeking alpha only within that asset class. According to SPIVA, over the past 20 years, more than 85% of large-cap active managers have underperformed their benchmarks. Similarly, the Morningstar Active/Passive Barometer has consistently shown that less than 20% of large-cap active managers outperform their passive counterparts over long periods. The challenge isn’t just stock selection – it’s the limited opportunity set. A more flexible return-stacking approach could allow investors to seek alpha from other sources, such as alternative asset classes and strategies, rather than relying solely on large-cap security selection.