4.2 Quick word on the dynamic approach
Recently, the EDHEC risk institute adapted the concept of
constant proportion portfolio insurance (CPPI) to propose a dynamic way to
manage a core/satellite portfolio. This later tends to tight the tracking error
by investing in passive strategy (low tracking error). Therefore, investors can
miss return improvement from active investment. This trend is stronger in
market downturns, during which active strategies must outperform passive
strategies.
The dynamic approach has the objective to avoid this
deficiency through an asymmetric management of the tracking error by using a
strategy to limit the underperformance of the core («bad» tracking
error) while take advantage from the upside potential of the satellite
(«good»
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tracking error). By using this approach, the managers are
going to shift some allocation from the core to the satellite when this later
outperforms the benchmark portfolio. On another hand, the satellite part in the
portfolio decreases if the active portfolios underperform the benchmark. This
approach generate always greater risk-adjusted returns than those from a static
approach, with an excess return above the benchmark about twice as large in all
cases 11 . Therefore, investors have to take into account this
management when they are holding a core/satellite portfolio.
But the risk control benefits from this approach need
consequent transaction costs due to the frequent rebalancing. This fact is
likely to affect the performance of a dynamic core-satellite portfolio. So
there is a trade-off between risk management and cost of trading. A less
frequent rebalancing leads to a more cost-efficient management and to a likely
consequent change in relative performance of the satellite with respect to the
core portfolio (higher period of time). This infrequency can mitigate the
result of this management by failing to get the guaranteed performance.
Increasing the frequency of trading could decreases the likelihood to fail.
Therefore, the presence of transaction costs is likely to be an important
concern to portfolio managers.
Moreover, this approach relies on active forecasting of the
future market performance, that grabs additional risk to the portfolio even if
the manager is a pretty good forecaster.
Finally, the high liquidity and relatively low cost make the
ETFs a natural tool to implement such dynamic strategies. They provide enough
liquidity for the frequent rebalancing of this approach.
Run a dynamic approach by using ETFs could be a great option.
Investors could take advantage from both : ETFs and the access to
outperformance provided by a dynamic core/satellite approach.
11. N. Amenc, P. Malaise, L. Martellini, "Revisiting
Core-Satellite Investing - A dynamic Model of Relative Risk Management",
EDHEC-Risk institute, November 2012.
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