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. Generally, core mutual fund consist of large-cap stock index mutual fund, which represents the largest portion of the portfolio
We all know that investing requires discipline. That is why many investors prefer to invest in mutual funds. Since mutual funds are run by professionals, these are considered good for those who do not have either time or knowledge to invest in shares and bonds. However, building a good mutual fund portfolio also requires planning. Let us discuss how to build a good mutual fund portfolio using core and satellite investing strategy.
Concept of core-and-satellite portfolio
Core-and-satellite is the most widely used and time-tested investment portfolio strategy. Core assets are an indispensable part of a portfolio without which one cannot realise one’s investment goals. Asset allocation in core assets is planned keeping in mind 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. Generally, core mutual fund consists of large-cap stock index mutual fund, which represents the largest portion of the portfolio. Satellite assets, on the other hand, require more active management or rebalancing than core assets.
Go with core and add satellite
For risk averse investors, one can build a core portfolio with a large proportion of debt and a small proportion in equities. For instance, 80% in debt and 20% in equity. This will preserve her capital and also help her cross the inflation mark. Similarly, one should not put more than 15-20% of one’s investments in satellite assets.
For instance, think of buying good stocks from mid-cap stock, small-cap stock, foreign stock, sectoral mutual funds, money market funds, etc. These satellites are the funds that will generally help the investor to achieve higher returns than the benchmark indices. Once you allocate an amount that is sufficient to achieve your goals, you can think about increasing satellite assets over a period of time.
One of the major benefits of the core portion of a portfolio is that it keeps investor expenses at the minimum. When expense ratios rise, investor returns take a hit. While small differences in expense ratios may seem minor on the surface, they can add up to a big impact over a period of time. One could observe that index funds carry the lowest fees.
The satellite gives investors the opportunity to tilt their portfolio in order to take advantage as per the prevailing market conditions. As the satellite approach involves active management strategies which create opportunities to react to various current events, adjust accordingly to either protect the portfolio or position it to make profit. Often, satellite portfolios could potentially deliver above-average returns without significantly altering the overall portfolio’s risk profile.
To conclude, the primary objective of this portfolio design is to reduce risk through diversification and at the same time obtain higher returns than a standard benchmark index. Core and Satellite portfolio strategy might help investors to achieve above-average returns with below-average risk for the investor.
The writer is a professor of finance & accounting, IIM Tiruchirappalli