Comparison of Risk Adjusted Returns in Core-Satellite Portfolios: Changing the Conversation to Benefit the Smaller Investor by John A. Molster, Jr. A dissertation submitted to the faculty of Wilmington University in partial fulfillment of the requirements for the degree of Doctor of Business Administration Wilmington University October 2018 Comparison of Risk Adjusted Returns in Core-Satellite Portfolios: Changing the Conversation to Benefit the Smaller Investor by John A. Molster, Jr. I certify that I have read this dissertation and that in my opinion it meets the academic and professional standards required by Wilmington University as a dissertation for the degree of Doctor of Business Administration. Signed ___________________________________________________ John L. Sparco, Ph.D., Chairperson of Dissertation Committee Signed ___________________________________________________ Ruth T. Norman, Ph.D., Member of the Dissertation Committee Signed ___________________________________________________ Mary B. Lavoie, D.B.A., Member of the Dissertation Committee Signed ___________________________________________________ Kathy S. Kennedy-Ratajack, D.B.A. Dean, College of Business Table of Contents List of Tables .................................................................................................................... vii List of Figures .................................................................................................................. viii Dedication .......................................................................................................................... ix Acknowledgments................................................................................................................x Abstract .............................................................................................................................. xi Chapter 1 Introduction ...................................................................................................................1 What Course Should a Small Investor Take? ...............................................................7 Problem Statement ........................................................................................................8 Significance of the Study ..............................................................................................9 Research Overview .....................................................................................................11 Research Questions and Hypotheses ...........................................................................12 Research Question Number One ............................................................................12 Research Question Number Two ...........................................................................14 Research Question Number Three .........................................................................16 Limitations and Assumptions ......................................................................................18 Definition of Terms .....................................................................................................18 Summary .....................................................................................................................20 2 Review of the Literature ............................................................................................21 Theory .........................................................................................................................21 Assessment Factors Relating to Risk Tolerance .........................................................22 Portfolio Construction and Asset Allocation ..............................................................23 Strategic vs Tactical Allocation .............................................................................24 Asset Allocation Approaches ......................................................................................27 Active vs Passive Management ...................................................................................28 Active Management ...............................................................................................29 Passive Management ..............................................................................................31 Combining Active and Passive Management ........................................................33 Two Portfolio Approaches to Core-Satellite ...............................................................33 Passive Core Approach ..........................................................................................34 Active Core Approach............................................................................................36 Variations to Core-Satellite Allocation ......................................................................37 Alternative Strategies for Small Investors .................................................................38 Target Date Funds ..................................................................................................38 Fund of Funds ........................................................................................................39 Study Measures ...........................................................................................................40 Sharpe Ratio ...........................................................................................................40 Sortino Ratio ..........................................................................................................40 Summary .....................................................................................................................43 3 Methodology ..............................................................................................................44 Morningstar Data ........................................................................................................46 Research Design .........................................................................................................47 Allocation and Measures of Study .........................................................................47 Extracting Data from Morningstar.........................................................................49 Selection of Index Proxies .....................................................................................51 Morningstar Methodology .........................................................................................51 Standard Deviation ................................................................................................52 Risk Free Rate ........................................................................................................53 Sharpe Ratio...........................................................................................................54 Sortino Ratio ..........................................................................................................55 Research Questions and Hypotheses ..........................................................................56 Research Question Number One ...........................................................................56 Research Question Number Two ...........................................................................58 Research Question Number Three ..........................................................................60 Limitations .................................................................................................................62 Additional Considerations ..........................................................................................62 Trading Costs .........................................................................................................62 Management Fees..................................................................................................62 Tax Implications....................................................................................................63 Summary .....................................................................................................................64 4 Results ........................................................................................................................65 Descriptive Statistics ..................................................................................................65 Hypotheses Tests and Findings ..................................................................................70 Summary .....................................................................................................................82 5 Discussions, Conclusions, and Implications ................................................................84 Summary of Research Findings ....................................................................................85 Possible Explanation for Results ..................................................................................87 Reflection of Study Limitation .....................................................................................89 Implications for Practice ...............................................................................................91 Recommendation for Future Research ..........................................................................94 Conclusions....................................................................................................................95 References ..........................................................................................................................96