As an investor, a portfolio of investments offers you many benefits. It gives a comprehensive view of the overall performance of your funds, allows you to manage and rebalance your investments to keep them in sync with your financial goals and replace underperforming or non-performing investments with the better alternatives. The list can go on.
However, building an investment portfolio is a difficult task. You need to start by determining your investment objectives, risk preference, and time horizon of investment. Once these three aspects can help you narrow down the list of assets that you might want to invest in, you need to determine the allocation of these assets. What portion of your investment would you allocate to assets like equity or debt or real estate, etc.? This process continues till you have the list of assets/investment instruments that you wish to buy to create your portfolio.
In order to make things easier and more organized, many investment strategies have evolved over years. One such strategy is Core Satellite Investing.
What is Core Satellite Investing?
In Core Satellite Investing, you divide your portfolio of investments into two parts – the core and satellite. The core consists of long-term investments which provide a stable platform for the satellites which are more specialized and/or short-term investments.
In a traditional Core Satellite Investing structure, the core investments included cost-efficient, long-term investments like index funds. On the other hand, satellite investments included other specialized investments have little or no correlation with the core investments. Together, they offer the benefits of asset allocation and an opportunity to outperform the market.
Benefits of Core Satellite Investing
- Spreads your investment risk between a large number of holdings
- Offers the benefits of multiple investment strategies
- Reduces the effects of market volatility on your portfolio
- Increases cost-efficiency
- Provides an opportunity to outperform the market
- Reduces the need for regularly rebalancing your portfolio
Asset allocation is the most important aspect of your portfolio. Many studies have shown that in the long-term, the right asset allocation usually provides a favourable investment outcome. You need to try to allocate assets in a manner that one asset can negate the drop in returns of the other and together they offer steady returns.
Also Read: What is an Investment Portfolio?
In modern times, Core Satellite Investing involves combining two investment approaches to managing investments in one portfolio – the passive approach and the active approach.
The Passive Approach to Investing
The passive approach to investing is a strategy that involves tracking a market index or portfolio. It is commonly known as the Index Approach or Index investing. In this approach, you invest in an index fund which tracks a specific market index. The fund managers try to generate the same returns as the index the scheme tracks, by investing in the same securities as tracked by the index or a representative sample of it. Also, most index funds hold their investments for a relatively long period of time.
The Active Approach to Investing
In the Active approach, the idea is to outperform the market by using your understanding of the market and investing in securities to generate good returns in a short time. Active fund managers constantly rebalance their portfolios to avoid losses.
In Core Satellite Investing, you use passive investing at the core and active investing as the satellites. This offers the following benefits:
Benefits of having Index funds at the Core:
- Cost-efficient – Being passively managed, index funds have lower administration costs and also require lesser research and analysis as compared to the actively managed funds. Therefore, they usually charge lower fees making them cost-efficient.
- Diversification – Since the fund tracks an index, it invests in a wide array of stocks. This reduces the risk of exposure to one particular stock and hence minimizes the risk associated with the volatility in prices of a few stocks. This diversification invariably reduces the volatility of the portfolio. However, since the fund tracks an index, if the index falls, the fund value falls too.
- Simple – Investing in Index funds does not require you to look at who is managing the fund or select an investment theme, etc. All you need to do is determine the market index that looks healthy to you and finds a scheme that tracks it.
- Fund Manager Independent – Unlike other mutual fund schemes, index funds are not dependent on the fund manager. Therefore, even if the fund manager changes, the performance of the scheme remains the same.
Benefits of having Actively managed funds as Satellites:
- Outperform the market – The idea of active management of investments is to generate better returns than the index. This is done by constantly analyzing the performance of various stocks and investing meticulously. Therefore, your investments have an opportunity to offer market-beating returns.
- Avoiding losses – Apart from selecting the stocks that might perform well, active investing also allows the managers to avoid stocks which might underperform and reduce losses to the portfolio.
- Choice – There are many active fund options available to choose from. These span different markets, sectors, geographies, etc. and offer a great choice for diversification.
Now that you understand the basics of Core Satellite Investing, let’s quickly look at how you can implement this approach:
- As specified earlier, before you start investing, determine your financial goals, risk preference, and time horizon of investment. This will help you narrow down to the list of assets that are appropriate to you.
- Spread the assets between core and satellite. This balance will depend on the amount of risk that you are willing to take. For example, a high-risk investor will push more funds into satellite than core while a low-risk investor will keep his core heavy.
- Choose the individual instruments that you want to invest in keeping this allocation in mind.
That’s it! By following this approach and creating an investment portfolio having a core of stable long-term investments and a periphery of specialized short-term ones, you can give yourself an opportunity to earn good returns. Remember, you should consult an investment advisor if you are new to investing or are unaware of any of these concepts.