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Does portfolio emulation outperform its target funds?

Author

Listed:
  • Zhe Chen

    (Macquarie Graduate School of Management, Australia; Capital Markets CRC Limited, Sydney, Australia)

  • F Douglas Foster

    (School of Finance, Actuarial Studies and Applied Statistics, The Australian National University, Australia)

  • David R Gallagher

    (Macquarie Graduate School of Management, Australia; Capital Markets CRC Limited, Sydney, Australia)

  • Adrian D Lee

    (UTS Business School, University of Technology, Australia)

Abstract

An emulation fund is designed to reduce trading activity, thereby lowering costs, for a multi-manager fund. It does this by delaying, and potentially combining, trading decisions from each employed fund manager to eliminate offsetting trades (e.g. one manager may buy a stock for her fund while another manager sells the same stock at approximately the same time for his fund). While lowering transaction costs is a key benefit of an emulation strategy, there has been little research that compares the reduction in transaction costs with the opportunity costs of delaying trade. Using reported equity trades for a large Australian pension fund, we simulate the consequences of an emulation strategy. We find that simulated emulation trades underperform those trades made by the employed (or target) fund over our sample period. That is, the opportunity cost of delayed trading significantly outweighs transaction cost reductions. Overall, we do not find strong evidence to support emulation from a cost–benefit perspective before management fees and taxes.

Suggested Citation

  • Zhe Chen & F Douglas Foster & David R Gallagher & Adrian D Lee, 2013. "Does portfolio emulation outperform its target funds?," Australian Journal of Management, Australian School of Business, vol. 38(2), pages 401-427, August.
  • Handle: RePEc:sae:ausman:v:38:y:2013:i:2:p:401-427
    DOI: 10.1177/0312896212455933
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    References listed on IDEAS

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    Cited by:

    1. Zhe Chen & F. Douglas Foster & David R. Gallagher & Adrian D. Lee & Steven Cahan, 2015. "A model of emulation funds," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 55(3), pages 717-748, September.
    2. Benson, Karen & Faff, Robert & Smith, Tom, 2015. "Injecting liquidity into liquidity research," Pacific-Basin Finance Journal, Elsevier, vol. 35(PB), pages 533-540.

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    More about this item

    Keywords

    Brokerage; fund-of-funds; market impact; multi-manager; offsetting trades; portfolio emulation;
    All these keywords.

    JEL classification:

    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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