Core and Satellite

Abstract

This is the second part of the author's article on core and satellite portfolio structure and focuses on implementation. Key issues include the choice of a core equity strategy, the desired allocation to active risk, and the satellite strategies used to pursue active returns. The author proposes a framework for integrating investment and investor-specific tax considerations into the allocation across equity risk, interest rate risk, and active risk. Four different types of satellite strategies are considered. They vary in their mix of active risk and equity beta. For each strategy, the framework allows for the calculation of an “information ratio hurdle.” This is the minimum gross information ratio the investor must expect from an active manager in order to justify an allocation to a satellite strategy. The required information ratio seems to be lowest for market-neutral strategies and highest for those satellites that mix a small amount of active risk with a high equity beta.

TOPICS: Portfolio theory, security analysis and valuation, risk management, performance measurement