If you thought that ‘core’ and ‘satellite’ terms are used only in geology or astronomy, THINK AGAIN!
These terms are often used to describe mutual fund investment strategies. A significant way to make a smart portfolio is to divide the investments into core and satellite.
Core and Satellite is a very old and proven investment approach of portfolio construction that is a part of the overall investment planning process. This approach is essential to generate and accumulate wealth in the long-term.
The primary objective of this portfolio is to reduce risk through diversification thus putting your eggs in different baskets while outperforming a standard benchmark for performance, such as the S&P 500 Index.
Before we proceed further to identify some of the benefits of core and satellite approach, let’s first define core and satellite assets.
As the name suggests, Core Assets, are central part of a portfolio without which one cannot realize their investment goals. Asset allocation in core assets is planned keeping in view the long-term goals of an investor and to generate higher returns with low risk. Core assets are the foundation of a portfolio and require passive management, which means occasional and not frequent readjustment is required in response to the market dynamics. The mix of core assets varies according to individual’s goals, risk appetite, time horizon, disposable income, age, and others.
For example, an investor with a long-term horizon and a high risk appetite, giving a higher weightage to equity in their portfolio would serve the investment goals as instrument like equity generates higher returns in the long term and not in the short term. Similarly, an investor with low risk appetite and short time horizon should allocate more in debt instruments than equities.
Satellite assets, on the other hand, require more active management or rebalancing than core assets. Portfolios are more than a collection of financial assets and the satellite investments must be selected and managed considering the portfolio as a whole
Satellite assets in the portfolio are more of a tactical approach, thus require active management and should not carry high weightage. They must be included to boost the overall return of a portfolio in a risk adjusted manner. You can try new strategies or newer themes to maintain portfolio with satellite assets.
Along with core and satellite, you should also consider creating Liquidity portfolio for the immediate needs of future to find liquidity without disturbing the investment portfolio. This will help the investor to manage liquidity, stability, and long term prospective to an investment portfolio. For liquidity portfolio, one can consider liquid funds that help them to generate stable and decent returns without a time commitment to investment.
Types of Core and Satellite Portfolios
There are different types of core and satellite portfolios – depending on risk profile and for particular goal that portfolio is constructed.
- For Risk-Averse Investor: You can build a core portfolio with debt instruments at higher ratio and the rest with equities. This will preserve your capital and also help you to cross the inflation mark.
- For Passive Investor: You can have Exchange Traded Fund (ETF) or Index funds over active investments like diversified equity mutual funds. Therefore, you can have 60-70% in passive investments and rest in active investments.
- For Aggressive Investor: Stability with some additional return is the need. Large cap are more stable than mid caps but mid caps can generate higher returns in the long run. So an aggressive investor, who still prefers stability, can have most of his investments in large cap but have some small amount in midcaps for some extra returns.
Benefits of Creating Core and Satellite Strategy for your portfolio
Here are 5 benefits of creating core and satellite strategy for your portfolio:
- Segregating your portfolio
Segregating your portfolio into two will help you to reduce churning cost of your portfolio. As large part of your portfolio will consist of Core strategy and needs minimum changes.
- Bringing down the management cost
The core and satellite strategy helps in bringing down the management cost. As you only need to target satellite portfolio with active management effort.
- Reduces the taxation burden
This strategy reduces the taxation burden significantly as most part of the portfolio can be untouched for a long term under core asset.
- Establishing better correlation
This strategy also helps in establishing better correlation to the broader index returns thus minimises the risk of ‘potential return lost’ and creates stable and in align return with index.
- Taking advantage of new concepts
Satellite portfolio helps you to take advantage of new concepts, ideas, sectoral and thematic approach in a smaller portion to boost overall risk adjusted return.
The Bottom Line
Therefore, Core-satellite seems to be the best approach as it helps to insure that the investors are well diversified among the different asset types, such as stocks, bonds and cash. Do you think this investment strategy makes more sense to you? Tell us what you think in the comments below.