Reaching medium risk exposure through non-fixed income ETFs

File pdf 803KB

Fixed income investments represent a significant part of diversified portfolios from private to institutional investors. The current very low interest rate environment means high potential risk for these fixed income investment holders. In this paper, we propose an alternative investment solution for “medium risk” profile investors - defined as 50% equity and 50% fixed income portfolio - with comparable return and risk characteristics but without any
fixed income products. The goal of this strategy is to protect medium risk portfolio against big losses in case of interest rate increase. We use Exchange Traded Funds (ETF) to compose our portfolios in order to provide an investable solution. To reach that goal, an originality of our
research is to select ETFs by an algorithm, namely PcGets. Based on this selection, we minimize the tracking error between our ETFs selection and our medium risk benchmark. Within the block search extension, it also allows to deal with database where the number of exogenous variables is greater than the number of observations. From a methodological standpoint, we compare the optimized PcGets portfolio with another one composed from a standard quadratic optimization. To complete our analysis, we add some constraints on tracking-error volatility for
each portfolios. We discuss the fact that adding constraints can substantially improve the performance of the portfolio selection. From an investment standpoint, a low volatility
combination of non-fixed income ETFs seem to provide an interesting alternative to classical medium risk portfolio.

Author(s):

Christophe Dispas    
Skema business school
France

Amaury Goguel    
Skema business school
France

Thomas Lanzi    
Skema business school
France

Hugo Pascail    
Université Côte d’Azur, SKEMA, CNRS, GREDEG
France