Philosophy: The Dynamic Nature of Generating Alpha
The dynamic nature of generating alpha requires an investment philosophy that:

• Is guided by sound investment intuition;
• Is disciplined, yet flexible and opportunistic; and
• Is applied to a broad universe of stocks

Key elements of Arrowstreet’s investment philosophy are discussed below:

A Focus on Behavioral and Informational Mispricings
While most managers focus on mispricings based solely on perceived informational advantages, Arrowstreet seeks to take advantage of both behavioral mispricings (e.g. value and momentum signals) and informational mispricings (e.g. earnings signals). Behavioral mispricings result from the tendency on the part of investors to respond to some information in a biased or inefficient way, while informational mispricings result from the market’s slow response to certain signals that are ultimately relevant to prices. Arrowstreet believes that exploiting multiple sources of mispricings diversifies the firm’s sources of value-added and improves the firm’s ability to add value on a consistent basis. Arrowstreet’s investment team continually monitors the contribution from existing signals and adapts the process to exploit new investment insights as markets evolve.

A Multi-Dimensional Approach to Investing
Arrowstreet’s approach recognizes the importance of evaluating investment mispricings on a direct as well as an indirect basis (e.g., country, sector, country/sector basket, and individual stock). For instance, ING Groep’s (a Dutch Financial) price is driven not only by its own unique characteristics, but also by characteristics common to all Dutch stocks, by characteristics common to Financial stocks around the world, as well as by characteristics common only to Dutch Financial stocks. Each of these characteristics can influence stock prices and their relative importance can vary over time. For example, the Technology, Media, and Telecommunications bubble of the late 1990’s presented unprecedented opportunities across sectors. When the bubble collapsed three years later, however, sectors became more fairly priced relative to each other, giving way to opportunities that were more bottom up or country driven. Arrowstreet’s strategy considers all of this information in an effort to generate more accurate forecasts.

Furthermore, the firm measures mispricings on a direct as well as an indirect basis in an integrated manner to uncover a richer set of opportunities. This is more efficient than a filtering or sequential-based approach to top down/bottom up analysis that could miss attractive stocks in marginally attractive countries or sectors. For example, the best technology stock may reside in a country that ranks as only marginally attractive. In a filtering or sequential-based approach, this stock could potentially be screened out in consideration of another, less favorable, opportunity.