Thematic portfolio optimization: challenging the core satellite approach

Florian Methling () and Rüdiger Nitzsch ()
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Florian Methling: RWTH Aachen University
Rüdiger Nitzsch: RWTH Aachen University

Financial Markets and Portfolio Management, 2019, vol. 33, issue 2, No 2, 133-154

Abstract: Abstract In recent years, thematic exchange-traded funds (ETF) have increased in economic significance. Investors in thematic ETFs have more than just financial objectives and gain a non-monetary added value from a thematic portion in their portfolios. Therefore, traditional portfolio optimization models which target only financial criteria cannot suit these investors’ needs anymore. Nevertheless, to account for their thematic interests, investors adapt a core satellite strategy in which conventional core portfolios and thematic satellite portfolios are combined. Thus, these portfolios are separately optimized without further considering inter-portfolio correlation effects. Since modern portfolio theory has originally been established to, inter alia, optimize these correlation effects, portfolios can only be efficient by chance. Therefore, this study targets the correlation effects between conventional and thematic portfolios and uses a tri-criterion thematic portfolio optimization model as an overall framework. Throughout a two-part analysis with tradable ETFs and a simulation with 250,000 draws and 1,750,000 portfolio optimizations performed, the status quo is compared to the tri-criterion model. Quantifying the suboptimality, simulation results show a mean portfolio improvement of 6.23% measured as relative yield enhancement. Further, our analysis concludes that the more narrowly a theme is defined and the more particular it is, relative yield enhancements can increase up to 46.88%.

Keywords: Portfolio management; Thematic investing; Portfolio optimization; Finance; Multiple criteria analysis (search for similar items in EconPapers)
JEL-codes: G11 G24 G4 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s11408-019-00329-0

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