There are many ways to build an investment portfolio. For example, you can decideto focus on just one area, such as UK equities, or cast the net wider for more globalexposure.
Which is the best option will depend on your investment needs, the amount of moneyyou can put away, and your overall attitude to risk.
Confident investors may choose to painstakingly blend together a wide variety offunds covering different asset classes, countries, and sectors. The less gung-ho,meanwhile, are more likely to buy a multi-asset portfolio instead and let the managermake all the important selection calls.
Another popular approach is known as “core and satellite”. Here we explain theconcept, highlight the potential benefits, and consider the possible downsides.
What is core and satellite investing?
Let’s start with a basic definition. ‘Core and satellite’ is a portfolio constructiontechnique that aims to help investors strike a balance between growth and risk. Itinvolves having a stable building block at the core, to which you add some riskier butpotentially more lucrative investments to the overall portfolio.
For example, core holdings can include index tracking funds that follow particularindices and generate a return in line with these markets. Alternatively, they may befunds that focus on stable, dividend paying large companies that have wellestablished, reliable business models.
The extra so-called satellite holdings will then hopefully add some extra spice, whilenot being a large enough percentage of the portfolio to cause major damage shouldthey underperform.
What are the benefits of a core and satellite investment approach?
The main benefit of this approach is providing a bedrock of investment performancewith the additional benefit of (hopefully) enjoying some extra returns. It also enablesinvestors to have some limited exposure to areas they may find of interest, justwithout taking too much risk when it comes to overall returns.
The core-satellite approach can embrace a variety of assets, including equities andfixed income, as well as being adjusted to suit an investor’s objectives and attitude torisk.
What are the downsides to a core and satellite investment approach?
As with any investment, there are no guarantees that the satellite positions willactually make you money. In fact, they may act as a drag on performance.
Such funds will also require more analysis, particularly if they cover sectors orindustries on which there isn’t a lot of easily accessible information. This research islikely to take a lot of effort. Potential investors will need to weigh up whether theyhave the time and inclination required.
As with all investment funds, you’ll also need to consider the impact of fees – interms of both core positions and satellite holdings. These charges will obviouslyimpact the overall level of returns enjoyed.
More niche funds, for example, may come with higher charges. If the satellite fundsubsequently delivers bumper returns, then the extra costs won’t be too much of aproblem. However, if it fails to meet expectations, then it will have more of anadverse impact.
What type of investor is best suited to a core and satellite approach?
An investor wanting the comfort of having most of their holdings in stableinvestments – with a small percentage in more exciting assets – could be drawn tothis approach.
Of course, what percentage of their overall investment they choose to put into thesatellite positions will influence the amount of risk being taken.
The more cautious investors will probably limit the amount held in such extra fundsto 5-10%. Those willing to take more risk, meanwhile, may opt to have more insatellites.
Choosing your core-satellite approach
Before you choose funds, you’ll need to decide which assets you want in the overallportfolio. For example, are you after a core of bonds of equities? Do you wantpassive index trackers or income producing actively managed funds?
FundCalibre doesn’t rate passive index trackers as our business is all about findingwho we think are the best active managers that can consistently beat these indices.
We do rate equity income funds that often fit into this core portion, however.
You can research all our Elite Rated UK equity income funds here and our EliteRated global equity income funds here.
Depending on the level of returns generated, the core-satellite mix will need to beregularly rebalanced to ensure it reflects the preferred asset allocation. It’s alsoworth revisiting your core-satellite approach on a regular basis to ensure it continuesto deliver the risk-reward that best meets your needs.
How to choose a core holding
A core holding will generally be a fund that has a decent growth target, with amanager at the helm that has a proven ability to deliver returns. Such portfolios willoften invest in stable, established companies that can usually be relied upon todeliver decent returns, irrespective of the economic backdrop.
These funds can generally be held for many years. For example, core funds mayhave a UK large cap mandate, which means they buy into the largest UK-listedcompanies.
Alternatively, they may have more of a global reach and the freedom toinvest in interesting companies across the globe.
How to pick satellite holdings
Having the opportunity to buy satellite funds means investors can have a bit of funwith their portfolios and put some money into areas that are of interest.
A satellite holding can be pretty much anything. For example, investors may choosefunds covering more potentially exciting areas such as the emerging markets. Theseportfolios will invest in companies within regions that are still developing and aren’tas closely followed as more developed markets.
This means that they have greater potential to deliver better-than-expected returns,which can translate into unexpected improvements in the stock price.
However, the downside is that returns will be more unpredictable. You’ll need toexpect a fair degree of turbulence by embracing these areas.
You can research all our Elite Rated emerging market equity funds here.
Other examples of satellite funds could be those investing in single countries likeIndia or China, or those investing in single industries, such as the insurance,healthcare, technology, or financial sectors.
FundCalibre categorises such funds as ‘specialist equities’ and you can find all the
Elite Rated options here.
