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Trader Talk: An Analysis of the Markets this Morning

Good morning,

Markets are called higher this morning after:

    • Japan’s government pension fund will buy more equities and overseas assets
    • Easing concern that Russia’s military intervention in Crimea will spur a broader conflict and disrupt markets
    • The European Central Bank is projected to hold interest rates at a record low today
    • Investors await U.S. jobs data after a private report showed fewer-than-estimated workers were added in February
    • China’s finance minister said economic growth below the government’s target is acceptable as lawmakers meet on policy in Beijing

    Core-Satellite investing

    Most of the time, active management is submitted to very restrictive constraints, with managers only allowed to deviate slightly from their benchmark. As a result only a limited part of the portfolio is actively managed, while the essential part of the portfolio passively replicates its benchmark, resulting in an overall portfolio with a low tracking error. For example, an active manager with a 5% tracking error constraint is in fact 95% passive. Meanwhile, high active management fees are paid on the whole portfolio. On the one hand, this approach is not efficient and leads to high management fees. On the other hand, it is not likely to favour outperformance, since managers are prevented from actually using their skills for making active bets. Instead of proceeding in this way, it is possible to associate active management and passive management in an optimal way, in order to get the best of both, using the core-satellite approach.

    The core-satellite approach consists in dividing the portfolio into a core component, which is passively managed and which fully replicates the investor’s specifically designed benchmark, and an active component, which is made up of one or several satellites of active managers, who are allowed to have a higher level of tracking error. The core portfolio can be typically made up of a pure index product. However, it is important to note that any long-term allocation between different indices can constitute the benchmark, which is not necessarily limited to market indices. The satellites will be actively managed, and typically will be invested on less efficient markets and will require more specialised managers. The allocation choice between the core and the satellite of the portfolio allows the investor to control a target level of tracking error for the whole portfolio, while authorising a very active management of a limited part of the portfolio. This approach allows for the improvement of investment management efficiency.

    The role of the core part of the portfolio is to control manager risk, whereas the role of active satellites is to provide investment diversification and to generate outperformance with regard to the benchmark. In other words, the core portfolio is the place where the management of the portfolio’s betas is performed, while satellites are where the management of the portfolio’s alpha is performed.

    European companies reporting results today:

    • Aggreko (AGK LN) 8am

    • Aviva (AV/ LN)

    • Axel Springer (SPR GR) 7:30am

    • Azimut (AZM IM) TBD

    • Balfour Beatty (BBY LN) 8am

    • Banca Popolare (BPE IM) 8am

    • Bureau Veritas (BVI FP) premkt

    • Cobham (COB LN) 8am

    • Continental (CON GR) 6:45am

    • Deutsche Telekom (DTE GR) 7am Preview

    • DS Smith (SMDS LN) 8am, 3Q sales

    • EasyJet (EZJ LN) 8am, Feb. traffic

    • Gemalto (GTO NA) premkt

    • Genel Energy (GENL LN) 8am

    • Hellenic Telecom (HTO GA) TBD

    • Hunting (HTG LN) 8am

    • IMI (IMI LN) 8am

    • Inmarsat (ISAT LN) 8am

    • JCDecaux (DEC FP) premkt

    • Merck KGaA (MRK GR) 7am

    • Orange (ORA FP) 7:30am Preview

    • RTL Group (RTL LX) TBD

    • Schroders (SDR LN) 8am

    • Spirax-Sarco Engineering (SPX LN) 8am

    • Telecom Italia (TIT IM) TBD

    Good day and happy trading!

    Kristian Camenzuli

    The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.

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