Efficient way to build a core-satellite portfolio by using exchange-traded funds( Télécharger le fichier original )
par Vincent LLOVIO
Université Toulouse Capitole 1 - TSE - Master 1 in Economics 2016
2 The core-satellite approach, what is it ?
2.1 Born from the failure of traditional portfolio construction
The modern portfolio theorem (MPT) and the capital asset pricing model (CAPM) indicate that return and risk are positively correlated and as well that a portfolio should be diversified in its sources of risk. Based on the MPT, the common approach to build a traditional portfolio is to take a long-term view by hiring active portfolio managers to implement allocations to stock or bond markets, with a diversification objective. The active managers are divided by size, style, and investment approach and evaluate their performance against a specific benchmark. For instance, growth managers are compared with a growth benchmark.
On one hand, traditional equity managers take position with a long-only constraint : they can own stocks but have an inability to go short and to use leverage. According to the analysis of Finn, Fuller, and Kling, shorting a stock can grab an opportunity to add value to a portfolio
which can be two times more benefit than an opportunity on the long side1 . Therefore, the return of a portfolio manager from the identification of an overvalued stock can be limited by this constraint. In other words, the long-only constraint put a stop to managers from fully implementing some of their views2 . For instance, constrained managers can use a negative insight only by underweighting a stock relative to its benchmark weight. In fact, a Traditional portfolio manager can derive little benefit from negative views. Note that, the long-only constraint becomes more binding as target tracking error increases. This later is a measure of active risk which comes from the attempt to beat the benchmark by the manager. In other words, an increase of active risk is translated into more views that are not fully implemented because of long-only constraint3 .
On the other hand, an active management can be successful if the managers detect market inefficiencies and have the ability to implement those insights, as we see before it can be pretty difficult. With this portfolio construction, the managers have to do two things at once. Firstly, they have to invest in the equity market to obtain the beta. Secondly, they try to add value through stock selection. They cannot focus on a specific task, so managers fully invest in the benchmark market at all time and keep low tracking error relative to this benchmark. One more weakness, this strategy requires large management cost for manager fees and rebalancing. To put in another way, the traditional portfolio construction has alpha-type costs to only get beta or less. Another point approves the previous sentence, managers tend to track the benchmark to avoid the risk of being fired, by consequent they dilute their alpha4 .
With regarding to the two previous point, there is some obstacle to have a benefit portfolio by using this strategy. Moreover, the asset allocation methods to achieve a return while keeping
a certain risk control, have non negligible limitations. The strategic asset allocation tends to give erroneous portfolio weight by not taking into account the movements in asset correlation through time. The tactical asset allocation relies on the correct and consistent prediction of the future price variation; the academic research showed that just few managers consistently have a right expectation. An academic research highlight this failure and the underperforming in general, 80% of active manage funds underperform the market. The part of fund which outperforms are often never the same which outperforms in the next period5 .
Furthermore, the tax code penalizes this traditional approach because its high turnovers increase the taxation of the market return. Therefore, it's very difficult for active managers to beat their benchmark, net of fees and after-tax basis, especially in strong bull markets.
That's why logically advisers were looking for a better way to manage an asset portfolio. The core/satellite was «born» from the issues in implementing a traditional portfolio. With this approach and its separation of alpha and beta, they found a way to avoid those constraints and allow a better concentration for each manager. By consequent, the core/satellite approach has rapidly become a major portfolio strategy of these advisers. The recent crisis helped this ascension.