Core & Satellite is a very old & proven investment approach. Portfolio construction is a part of the overall investment planning process, that is essential to generate and accumulate wealth in the long-term. Almost everyone has some kind an investment portfolio consisting of assets. For instance, a person having a fixed deposit of, say, Rs 1 lakh and post office savings of Rs 75,000 can also be called portfolio.
You must have read or heard that an investor should have a diversified portfolio. So there are two important terms Diversified & Portfolio.
Diversification – it is dividing your money in different assets or investments. Why? “Don’t keep your eggs in one basket” because if it falls all eggs will be broken. So one should invest his money in different assets like equity, debt, real estate & gold – it should also be further divided on investment level like 5-6 equity funds, 2-3 debt products.
Portfolio – it is a combination of all your investment for a particular goal or all goals or just for wealth creation.
The systematic method of portfolio making involves several factors that come in steps. These include identifying investment goals, assessing one’s risk appetite, deciding on asset allocation as per goals, determining a time horizon, and diversification of asset classes to minimise risk and weather market volatility. The ultimate goal of systematic portfolio making is to maximise returns and minimise risks.
Core & Satellite Portfolio
A significant way to make a systematic or smart portfolio is to divide the assets into core and satellite segments. Core assets, as the name suggests, are an indispensable part of a portfolio without which one cannot realise his/her 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, among others. For instance, for an investor with a long-term horizon and a high risk appetite, giving a higher weightage to equity in his/her portfolio would better serve the investment goals as a high-risk instrument like equity generates 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. One should not invest more than 15-20% of his investments in satellite assets. Once you allocate amount that is sufficient to achieve your goals – you can think about increasing satellite assets.
Now the question is which should be core assets & which should be satellite assets.
Types of Core & Satellite Portfolios
There are many types of core & satellite portfolios – depending on risk profile & for particular goal that portfolio is constructed.
For risk-averse investor: He can build a core portfolio with most of debt instruments & rest with equities. This will preserve his capital & also help him cross inflation mark. Eg. 80% in debt & 20% in equity.
For Passive Investor: Such investors prefer passive investments like ETF/Index funds (check DSP Black Rock Nifty Index Fund & how its different) over active investments life diversified equity mutual funds. So they can have 60-70% in passive investments & rest in active investments. Internationally this is the most common meaning of Core & Satellite. Check its benefits.
Stability with some additional kick: If we talk about equity stocks/funds – 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 kicker. HDFC Mutual Fund is having a fund based on this strategy.
HDFC Core & Satellite Fund Investment Strategy – The net assets of the Scheme will be invested primarily in equity and equity related instruments in a portfolio comprising of ‘Core’ group of companies and ‘Satellite’ group of companies. The ‘Core’ group will comprise of well established and predominantly large cap companies whereas the ‘Satellite’ group will comprise of predominantly small-mid cap companies that offer higher potential returns but at the same time carry higher risk. The ‘Satellite’ group will complement the ‘Core’ group. The ‘Core’ portion is expected to be between 60-80% of the portfolio.
For Aggressive investors: People who feel that they can do better than advisors & fund managers can also make their portfolio in 80% pooled investments & 20% direct equity.
You can design you own core & satellite portfolio strategy
Similar to what is mention in the above types – you can design your own portfolio. Let’s talk about your retirement portfolio – assuming you still have 15-20 years in that. You have medium risk profile & wanted to have 50% of the amount in equities. After reading the concepts you decided to structure your portfolio in 2 parts – core (80%) & satellite (20%).
Your Core Portfolio – 80%
Diversified Equity Mutual Funds – further divided in Large Cap & Mid Cap
Half amount is going in EPF and rest of the amount is divided into PPF, Bank FD & Debt Mutual Funds.
Your Satellite Portfolio – 20%
- Direct Equity/Commodity – 5%
- Sector Fund or Quant Fund– 5%
- NCD – 5%
- Private Debt (Loan to neighbor) – 5%
Try to seal core & satellite portfolio in air tight compartments so that they should not impact each other. Sometime you can move money from Satellite to Core but never vice versa – this will make sure that even if your risky bets don’t perform as expected, still you will be in position to reach closer to your goals.
Do you think this strategy makes some sense to you?