Core & Satellite Portfolios

 The core – satellite strategy is a method of portfolio construction that allows investors to focus on long term financial goals while minimizing volatility, costs & taxes. In this approach, investors differentiate between two segments in their portfolio. The core portfolio is geared to meet the long term goals and strategies needs of an investor. It should form at least 60%-70% of the portfolio. Investments that are part of the core are long term holdings; changes in the core portfolio are made only when there is a change in investor’s needs, objectives or life stage.

The core should ideally consist of passive investment that tracks major market indices, such as index funds. Alternately, investments that are geared to generate market returns are also suitable for the core portfolio needs. For example, diversified equity funds and large cap funds are funds that generate debt investment returns in line with market rates.

The satellite portfolio should include actively managed investments. These investments are tactical in nature and form a smaller part of the total asset allocation of the investor. Satellite investments are managed in order to benefit from economic and market conditions. The higher risk-adjusted returns that these investments provide push up the overall returns of the portfolio. For example, long term gilt funds seek to gain from an increase in the price of securities when interest rates are declining. Sector specific funds benefit when the economic conditions are suitable for the particular sector. However, management of satellite assets requires that investors must be able to identify the right time to invest and exit from the investment.

Core portfolios can be focused on earning a return close to what the benchmark for an asset class offers. The booster to the portfolio’s return can be earned from the satellite portfolio, which tries to add value over and above the benchmark returns.

The core portfolio provides stability and long term appreciation. The core portfolio offers an extra risk-adjusted return that pushes up overall portfolio returns. Since investment that form part of the core portfolio is not churned frequently, there is a reduction in transaction costs and volatility for the investor. Liquidation for meeting cash needs is usually done from the satellite portfolio. As a result the impact of transaction costs and tax incidence on trading gains is limited to the satellite portfolio. The core part of the portfolio controls manager risk, while limiting management fees. The active satellite assets provide diversification benefits and possible outperformance of the benchmark.