3.2 ETF in this portfolio approach
With the introduction of ETFs, the use of a core/satellite
strategy becomes a very practical strategy for the investor to implement. In
general, investors use ETFs to control different aspect of their portfolios, to
satisfy their individual investment preferences. ETFs provide a simple way to
implement a professional style approach to portfolio management. In the case of
this strategy, this instrument can have different functions. Even if, the main
use of ETFs remains long-term buy and hold into market indices (core approach),
it can act in the core and as well in the satellite.
3.2.1 ETFs in the core
According to the previous section, we can say that a low-cost
diversified portfolio can easily be constructed with a few ETFs to cover the
major equity asset classes and the fixed-income
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market. In fact, investors use several ETFs as core position
to generate low cost beta thanks to an optimal allocation between them. By
consequent, they get an instant and great diversification and reduce overall
portfolio risk. As well, they can only use one index ETF to get a diversified
market exposure without taking stock selection decisions. The use of only one
manager can reduce the cost. Thanks to the myriad of ETFs, investors can
diversify risk against most of financial asset.
Moreover, the using of some ETF as the core
position allows an easier rebalancing. For instance, if an investor wants to
increase his equity exposure, the purchase of additional shares of an ETF makes
it easy to do without having to buy additional shares for current holdings.
Therefore, ETFs can grab the same outcome than index funds in
the core part of a portfolio (diversified portfolio which provides beta
return). But they take an advantage over index funds thanks to their
characteristics like their cost efficiency (fee, tax), their transparency, or
their high liquidity. This later provides a higher handling ability than index
fund.
3.2.2 ETFs in the satellite
ETFs are less suit to the satellite part because most of them
are passively managed, so we can think that just produce beta and low turnover.
But they can have a useful role in the satellite. Investors can use them to
spread risk and enhance potential return.
ETFs in the satellite provide a better tactical overlay.
Effectively, some ETFs can capture the risk premium performance of certain
asset classes (e.g. value stocks). So ETFs that are not broadly diversified,
such as industry sector ETF or maturity-segment ETF,
can be used in a tactical way to enhance the performance of the whole
portfolio. In the satellite, ETFs provide opportunities for outperformance.
Moreover, ETFs have several advantages over active funds. ETFs have low
turnover per year. So using ETFs in the satellite is tax effective to produce
alpha. Then the active fund satellite suffers of lack of transparency, risk
control and liquidity;
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by introducing them, ETFs could dilute this issues. It can be
a valuable added value in the portfolio regarding to the features of actively
managed funds.
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