Optimal Holdings of Active, Passive and Smart Beta Strategies

Abstract

The growing dominance of the core and explore model – a large passive index combined with a collection of high tracking error satellite portfolios – in conjunction with the growth of factor investing has renewed interest in how to allocate among different equity strategies. We study this problem from an expected shortfall perspective and find that portfolios that minimize expected shortfall differ substantially from portfolios generated using conventional methods.

Keywords: Portfolio Management, Smart Beta, Factor Investing, Passive Index, Enhanced Index, Factor Allocation, Asset Allocation, Modern Portfolio Theory, Mean Variance, Tracking Error, Shortfall, Optimization

JEL Classification: G11