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Smart Beta Generates Smart Alpha. The S&P 500 Is Not Smart.

Feb. 10, 2016 8:10 AM ETSPY2 Comments
Ronald Surz profile picture
Ronald Surz


  • Core-satellite investing has been embraced as a way to diversify and to lower costs, but the S&P 500 as core does neither.
  • The S&P 500 undermines active satellite managers with deadweight stocks, thereby reducing alpha and raising cost.
  • There is a better core. It’s smarter beta that generates smart alpha by bringing out the best in active managers.

Core-satellite investing continues to be very popular, combining a passive core portfolio with active satellite managers. It's an active-passive approach. The original purpose of the core portfolio was a completeness fund, rounding out a team of specialist active managers.

In its simplest form, an active growth stock manager and an active value stock manager are rounded out by a passive core, but the common practice for this core needs improvement. In practice, "core" is almost always a total market index, like the S&P 500, so it dilutes active satellite managers rather than completes them. The S&P 500 is value and growth and core, all wrapped into one.

Somewhat ironically, the S&P as core actually results in an unintended bet against true core, defined as the middle of the market, in between value and growth. I call this middle of the market "Centric Core" to contrast it to the blend that is typically used as "core." To be precise, centric is the 20% in the middle. The S&P is not true core; in fact it's only 20% pure core. So even if you allocated as much as 80% to the S&P as core, you would have only 16% (20% of 80%) in true core, which is less than the market weight of 20%.

A more efficient and diversified approach would be to allocate just 20% to centric core and 80% to active satellite managers, thereby obtaining market diversification. Centric core is to value and growth as mid-cap is to large and small. Unless you have particular timing skills, it's best to diversify among sizes and styles.

Allocating more to active satellite managers should result in higher alpha for the total portfolio if the active managers are producing alpha, which is a reasonable supposition since they would only be hired if they were

This article was written by

Ronald Surz profile picture
I'm president of  Target Date Solutions, developer of the patented Safe Landing Glide Path , Soteria personalized target date accounts, and Age Sage do-it-yourself investing. I;m also co-host of the Baby Boomer Investing Show.   My passion is helping his fellow baby boomers at this critical time in their lives when they are relying on their lifetime savings to support a retirement with dignity, so he wrote a book Baby Boomer Investing in the Perilous 2020s and he provides a financial educational curriculum I'm author of 3 books: Baby Boomer investing in the Perilous Decade of the 2020s, & 2 books on target date funds I’m smart with 2 Masters degrees and 55 years in financial consulting. I’m semi-retired, and prefer helping my fellow baby boomers rather than playing golf. I’m worried that our country, & most others, is playing with fire in its money printing. I’m here to help – that’s my legacy space.I help investors deal with life’s investment challenges, with the objective of enjoying a comfortable long retirement. I’m passionate about questioning and improving upon entrenched stale practices like jamming everyone into cookie cutter model portfolios. That's why I produce the Baby Boomer Investing Show live on Youtube and Facebook every other Tuesday at 10:00 PST. Watch live or replay by searching for "Age Sage Robo" on Facebook or Youtube. Please watch and support our Boomer Investing Show on Patreon ( https://www.patreon.com/user?u=35204315&fan_landing=true ) and visit our SA Blog at https://seekingalpha.com/account/authorboard/instablog . As president of Age Sage Robo (please Google), and CEO of GlidePath Wealth Management, I’m responsible for model development using my patented process . I have more than 50 years of financial service experience and hold a U.S. Patent for a time-tested glide path investment process that helps investors navigate the complicated financial decisions they face as they accumulate and preserve assets for their retirement years. Age Sage & GlidePath use this process to build Target Date, Special Purpose, and Life Span Portfolios that are tailored to the specific requirements of clients. My extensive financial career began at A.G. Becker Pension Consultants where I advised on the investment policies of several trillion dollars of retirement plan assets. After Becker I started my own consulting firms that developed innovative services for investors and the financial advisors who serve them. I’ve earned a BS and MS in Applied Mathematics from the University of Illinois and an MBA in Finance from the University of Chicago. I am author of the book "The Remarkable Metamorphosis of Target Date Funds" and co-author of "The Fiduciary Handbook for Understanding and Selecting Target Date Funds"Please visit https://babyboomerinvesting.show

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Please place this in the FA folder for Gil

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Comments (2)

"Allocating more to active satellite managers should result in higher alpha for the total portfolio if the active managers are producing alpha..."

If A -> B, therefore if A -> B.

"...which is a reasonable supposition since they would only be hired if they were expected to produce value-added. Result: Smart Alpha."

Quite the assumption given that the vast majority of active managers generate no alpha in the long run after costs and fees.

If I can try to summarize the article: this is a long way of saying the optimal portfolio is an element of Beta with an Alpha overlay. Beta is easy to find (but people are perhaps paying too much for the Beta by misunderstanding what SPX replication is truly giving them), while Alpha is expensive/difficult to find.
Ronald Surz profile picture
That's it. Most advisors don't have the time, energy & money to get serious about Alpha, but those who do shouldn't waste it by adding in the S&P500.
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