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Risk Control through Dynamic Core-Satellite Portfolios of ETFs: Applications to Absolute Return Funds and Tactical Asset Allocation — January 2010

2. Beyond Diversification: Absolute Return Funds of ETFs

Exhibit 1: Absolute return fund: change in the core, the satellite, the floor and the dynamic core-satellite portfolio

We can draw a number of conclusions from this figure. The dynamics of the core portfolio confirm the conservative character of the core investment, but we also see that the performance of the bond core was fairly flat for some extended periods, such as from 1999 to 2000 or from 2004 to 2006. The returns of the equity ETF in the satellite portfolio were, by contrast, negative over the entire period. The fluctuations in the value of the large-cap

equity ETF in the satellite are tremendous, with a sharp increase before 2000 and steep falls from 2000 to 2002 and in 2008. The dynamic core-satellite (DCS) combines the advantages of each of its ingredients, namely the smooth performance of the bond core and the upside potential of the equity satellite. As a result, performance is smooth over the entire period, and cumulative returns at the end of the period are actually higher than those of both the

Exhibit 2: Absolute return fund: changes in the allocation to the satellite

An EDHEC-Risk Institute Publication

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