Does the following explanation make sense?
Completeness fund:
Start with an existing active portfolio position that has its own “normal portfolio/benchmark” that reflects its style. However, if hired by an investor, the active manager may be compared to a broad-market index, the “investor’s benchmark”. Thus, add positions to a completeness fund which, when combined with the active portfolio, will match overall risk exposures of the “investor’s benchmark”, eliminating misfit risk
Thanks!
makes sense to me. Does a core satellite approach make sense to you? If it does, then flip it and you have completeness fund pretty much.
Well not all investors will want to “eliminate” misfit risk. It depends on their goal. If they want to mimick their portfolios benchmark then yes, you would to complete the portfolio to eliminate misfit risk. However, if they still want some active risk and/or alpha then you will need some misfit risk or active risk.
thanks guys
Just to recap:
An investor can also use a completeness fund to minimize active risk. In this case an investor combines the completeness fund with the active portfolio to better match the risk factors of the underlying benchmark. The main advantage of this approach is that it offers better risk matching while still allowing the active manager the freedom to pursue higher active returns (although that freedom or overall active return might be dampened). Basically we reduce misfit risk but can sacrifice some active returns to do so. This is similar to alpha/beta separation and a core-staellite approach in the sense they all try to generate some active return while minimizing active risk.
Where: True Active Return = Managers total return – Manager’s normal benchmark portfolio