Valentyn Khokhlov


The purpose of this paper is to develop a mathematical alpha-beta separation model that can be used to create a core-satellite portfolio management strategy that complies with the principles of Islamic finance. Methodology. Core-satellite portfolio construction methodology is used to implement the alpha-beta separation approach, where the core part of the portfolio is managed using the tracking error minimization strategy, and the satellite part of the portfolio is managed using the mean-variance optimization strategy. Results of the portfolio dynamics clearly show that a significant amount of value was created by alpha-beta separation. The typical alpha ranges from 4% to 5.7%. The most aggressive portfolio strategies that allow short positions in the satellite portfolio work best with frequent rebalancing and benefit from the active bets. Smoothing technique that was introduced to decrease the portfolio turnover and stabilize its composition works better when active bets are less efficient, particularly with less frequent rebalancing. The best risk-return combinations are achieved with modest (3% to 10%) allocation of the total portfolio to the satellite, and the remaining part (90% to 97%) being managed in order to minimize the tracking error. Practical implications. The alpha-beta separation framework suggested in this paper can be used to enhance the portfolio management techniques for the hedge funds that operate under tight restrictions, particularly under the Islamic finance principles. The mathematical models developed in this paper allow practical implementation of the alphabeta separation concept. Originality/value. While the idea of alpha-beta separation existed in hedge fund management before, there was no comprehensive mathematical model under it, so its implementation was based on the ad hoc approach. This paper introduces such a mathematical model and demonstrates how portfolio managers can create value for their clients using it.

How to Cite

Khokhlov, V. (2016). ALPHA-BETA SEPARATION PORTFOLIO STRATEGIES FOR ISLAMIC FINANCE. Baltic Journal of Economic Studies, 2(4).
Article views: 530 | PDF Downloads: 3



portfolio management, hedge funds, alpha-beta separation, core-satellite portfolios, Islamic finance.


Caliman, T., D’Hondt, C., Petitjean, M. (2013). Determining an optimal multiplier in dynamic core-satellite strategies. Journal of Asset Management, volume 14, issue 4, p. 210-227.

Chin, P.F. (2010). The Core-Satellite approach – The case for beta. InFinance, volume 124, issue 2, p. 30–32.

Ismail, A.G., Tohirin, A. (2010). Islamic law and finance. Humanomics, volume 26, issue 3, p. 178–199.

Jawadi, F., Jawadi, N., Louhichi, W. (2014). Conventional and Islamic stock price performance: An empirical investigation. International Economics, volume 137, p. 73–87.

Jorion, P. (2003). Portfolio Optimization with Tracking-Error Constraints. Financial Analysis Journal, volume 59, issue 5, p. 70–82.

Khokhlov, V.Y. (2011). Tracking Portfolio Optimization. Economic Bulletin of the National Mining University, volume 2, p. 140-144.

Leibowitz, M.L., Bova, A. (2005). Allocation Betas. Financial Analysts Journal, volume 61, issue 5, p. 70–82.

Markowitz, H. (1952). Portfolio Selection. The Journal of Finance, volume 7, issue 1, p. 77–91.

Patel, E. (2008). Fundamentals of Islamic Finance. Accountancy SA, Jun 2008, p. 41–42.

Roll, R. (1992). A Mean-Variance Analysis of Tracking Error. Journal of Portfolio Management, volume 18, issue 4, p. 13–22.

Rudolf, R.A., Wolter, H.-J., Zimmermann, H. (1999). Liner Model for Tracking Error Minimization. Journal of Banking & Finance, volume 23, p. 85–103.

Treynor, J.L., Black, F. (1973). How to Use Security Analysis to Improve Portfolio Selection. The Journal of Business, volume 46, issue 1, p. 66–86.