Core-satellite approach makes for a winning combin
It is thanks to an asset management style that is based on a highly effective model of core and satellite investments that the Madrid-based pension fund Fonditel believes it finds itself ranked over and over again among the best in its class for profitability and has won highly regarded awards from leading groups such as Standard & Poor’s and Morning Star.
Fonditel explains the objective of the model is to add value and consistency and this is attained using modern portfolio management techniques.
The core-satellite structure that dominates Fonditel’s asset management policy is based on the portfolio’s central asset classes of equities and fixed income both heavily tracking their respective benchmarks and indices. Using the EuroStoxx-50 for equities and the JP Morgan EMU Fixed Income as fundamental indices, Fonditel says its management style is “active management of passive indices”, which means it either actively manages the distribution and over and underweightings of the different asset classes comprising the core or it acts to reduce the duration of fixed income assets with respect to the evolution of anticipated interest rate changes. The satellites, however, are no practical drain on resources and thus are managed internally with the objective of producing positive returns that have little correlation to the fundamental indices.
The core investments track fixed income indices to the same extent as they do equities and the satellite investments. Movements in the markets and the way Fonditel’s own investments develop are the determining factor in the way it sets weightings per asset class. Fonditel says core investments benefit from strategies that are implemented in the traditional financial markets using basic investment tools whilst the satellites are designed to generate profit without the need to consider systematic risk.
The strategies outline two main alpha generators in the form of fixed income and equities which are dependent on their respective markets. Fixed income alpha includes strategies that rely on the relative value between different bonds or curve yields; the relative value between the curves of different countries or blocks of countries; the credit differentials between bonds and other fixed income instruments, such as swaps, whilst the most common strategies for equities alpha include relative value between similar stocks; equities and sectors measured against the indices they belong to; arbitrage, mergers and acquisitions, and the relative value between equity indices and different countries.
According to Inverco, Fonditel’s rate of return has consistently outperformed that of its private and occupational counterparts in Spain in the past five years. In 2003, Fonditel’s profitability reached 18.99% compared to 4.53% for other Spanish personal pension plans and 6.73% for occupational schemes. Similarly, it has outperformed the reference indices as well its own benchmarks in most cases over the same time period. Fonditel’s 18.99% compares favourably to the EuroStoxx-50 rate of 15.68%, JP Morgan EMU Fixed Income’s rate of 3.98% and the fund’s own benchmark return rate of 9.83%. Similarly, the track record over three and five years is impressive.
Fonditel points out that, over the two years to June 2004, in addition to returns of 14.36% against benchmark of 7.76%, its volatility, as measured by typical monthly annual return deviations, was 6.33% (8.04%) and the Sharpe ratio was 2.01 (0.72).
Highlights and achievements
It is an endorsement of the success of Fonditel’s core-satellite investment strategy that the fund is systematically ranked among the leaders in its class in Spain as well as picking up various awards from prestigious financial organisations.
Fonditel’s unwavering faith in its active management style, something that is uncommon in Spain, is justified in research results that show Fonditel’s superior performance over the past five years compared to other Spanish pension funds, both private and occupational, and compared with its set benchmarks and indices.
Keeping a close eye on the core assets by heavy index tracking whilst allowing the satellite investments to roam more freely successfully ensures high profitability with low correlation and costs as well as effective risk management. The ability to systematically alter the weightings of its core assets means the fund doesn’t have to be overly concerned about changes and periods of volatility and uncertainty in the financial markets.