By: Noël Amenc, Edhec Business School & Lionel Martellini, University of Southern California
Published: February 15, 2003

This is a complex academic paper and is tough to read.  However, beginning on page 44, professors Amenc and Martellini discuss mathematical models to determine the optimal amount of hedge funds in a “core/satellite” (i.e. portable alpha) investment approach. 

“Given that most active managers still have dominant passive exposure to their benchmark, instead of paying high fees on the passively managed part of their portfolio, the core-satellite approach suggests passively investing in a low-fee index fund (or an enhanced index product) as a core portfolio and investing in a variety of satellite active managers with higher tracking error.”

“…investors may want to invest in market-neutral managers who provide only portable alpha benefits without passive exposure to the index, so that they only compensate active managers for their abnormal returns, not for their passive exposure to rewarded sources of risk.”

“…a satellite/core approach seems to be perfectly suited for investors who attempt to use hedge funds to add portable alpha benefits to their long-only portfolio without modifying their passive exposure to a reference index…”

Surgeon-General’s Warning: take an aspirin before trying to read this paper.

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