By Hemanth Gorur
Investment approaches and strategies have proliferated in the last two decades, to the extent that investors tend to get confused between similar strategies. The core-satellite portfolio strategy is one such approach, which can be mistaken for the static asset allocation strategy in vogue. Let us decode the core-satellite portfolio strategy and review its applicability.
What is core-satellite portfolio
The concept of core-satellite portfolio has its origins in the selection of passively managed and actively managed funds to construct investment portfolios. While passively managed funds provided long-term stability and formed the core portfolio, actively managed funds can yield higher returns and form the satellite portfolio. Passively managed funds entail low cost and lack of fund manager involvement, substantially bringing down the risk of the core portfolio. Actively managed funds typically entail higher risk but also are more likely to yield higher returns, making them ideal for tactical changes to the portfolio.
Importantly, the core portfolio should comprise a major part of the overall portfolio, stay relatively untouched, and money should never be withdrawn from it before fulfillment of identified goals. The satellite portfolio can be partially liquidated when appropriate.
In recent years, it has become an accepted approach to have both the core and satellite portfolios to comprise both actively managed and passively managed investments, with the rider that the core should be “stable and unchanged in composition” while the satellite could be “riskier and alterable”.
How it differs from static asset allocation
Core-satellite portfolio strategy is not the same as static asset allocation strategy, which dictates that the percentages of the four asset classes of equity, debt, commodities, and real estate in your portfolio are fixed in line with your financial goals, financial situation, investment horizon, and risk appetite. Taking just equity and debt for illustration, let us say your target allocation was 60:40 in favour of equity. Also assume you would want your core and satellite portfolios to be in the ratio 75:25. You now have four portfolio buckets you need to fill with investments of your choice: Core-equity, core-debt, satellite-equity, and satellite-debt.
This could be achieved by including, for instance, a benchmark index fund (20% of overall portfolio), a large cap fund (10%), and a mid cap fund (10%) in the core-equity bucket. The core-debt bucket could comprise government securities or G-Secs (20%) and fixed deposits (15%). Similarly, the satellite-equity bucket could have a small cap fund (10%) and a dividend yield fund (10%), while the satellite-debt bucket could include a floater fund (5%).
Precautions for core-satellite strategy
One misconception is that the core needs to comprise entirely of debt or risk-free investments in order to be stable. Again, the satellite portfolio can be confused for a purely equity portfolio since it is supposed to yield higher returns at higher risk. But long-term debt instruments also have a higher risk-return profile. Also, the equity-debt target allocation need not be achieved individually in the core and satellite portfolios. Rather, your overall portfolio should reflect the target asset allocation ratio.
Finally, the choice of investments for each of the four buckets are specific to the individual and need not be identical across investors as their investment preferences and risk profiles will vary.
Before using the core-satellite portfolio strategy, understand the differences from traditional asset allocation approaches, construct a few alternative core-satellite combinations that meet your target allocation, and choose one that you are comfortable with.
The writer is founder, Hermoneytalks.com