Your investment portfolio is the total value of the assets such as mutual funds, direct stocks, and fixed deposits. So, even if the total value of your assets is Rs.1 lakh, it would also be called an investment portfolio. There are different ways to design your investment portfolio.
And one of the ways to build a portfolio is the core and satellite portfolio strategy.
This article will look into core and satellite portfolio strategy, its benefits, and how investors can implement it.
Essentially, the core-satellite investment strategy was meant to combine passively managed funds with actively managed funds. The passively managed funds would constitute the core portfolio, and the active funds would make up for the satellite portfolio. However, one can frame a core and satellite portfolio by segregating mutual funds based on their underlying asset classes.
As the name implies, core assets are an essential component of a portfolio without which one cannot achieve their investment objectives. Core asset allocation is established with an investor's long-term objectives in mind and is designed to generate returns by taking the risk suitable to the investor. The core portfolio is built by investing in various assets per the investor's objectives, risk tolerance, time horizon, available funds, age, and other factors.
The main objective of the core portfolio is to provide stability to the overall portfolio to achieve long-term goals.
The investments in satellite portfolios are tactical allocations where a comparatively higher risk is taken to get higher returns. However, the total investment in the satellite portfolio is lower than the core portfolio so that the higher risks don't adversely affect the portfolio's growth.
The satellite portfolio requires more rebalancing than the core portfolio. It is because, in the case of satellite portfolios, we are trying to earn higher returns and, as a result, investing in assets that are likely to generate higher returns.
Typically, people should not have more than 15% to 20% of their total portfolio in satellite assets.
How does core and satellite portfolio work?
One of the most important aspects of investing is having a diversified portfolio. It is essential because a diversified portfolio protects your investment value when one investment is losing value.
A mutual fund is the simplest investment option that helps investors diversify and build a core and satellite portfolio.
With this investment technique, you can have the best of both worlds, i.e., stability and high growth, without sacrificing your objectives.
Having a core and satellite portfolio ensures that your goals are secured even if some risky investments don't turn out as planned.
Types of core and satellite portfolio
One can create different core and satellite portfolios depending on the risk tolerance and investment goals.
But for simplicity, we have divided the types of core and satellite portfolios into three categories for the three types of investors: conservative, medium risk-taker and high risk-taker.
Conservative investors are investors whose main investment objective is protecting capital and getting returns that beat inflation.
For investors who can't take the risk, investing a significant part of their portfolio in debt funds might be an ideal option. It is because the main objective of these options is to protect money.
And for the growth part, a satellite portfolio can be made up of a combination of actively and passively managed large-cap equity funds. Large cap funds invest in market leaders and are in a better position to withstand the ups and downs of an economy.
Medium risk-taker investor:
A medium risk-taker investor will have a core portfolio with relatively stable investments and a satellite portfolio with risky investments.
The core portfolio can consist of large cap funds and equity-oriented hybrid funds that are relatively stable than the mid cap or small-cap funds. Moreover, debt funds can also form a significant part of the core portfolio.
On the other hand, the satellite portfolio can consist of riskier investment options such as mid cap funds to provide the extra returns.
For an investor, who can take high risk, pure equity funds, including passive and active funds, can constitute a major part of the core portfolio. Sectoral funds and international funds can be a part of their satellite portfolio. Sectoral funds are riskier than diversified funds as it invests in funds that belong to only one particular sector. As a result, if the investment and exit take place at the right time, sectoral funds have the potential to deliver higher returns than diversified funds.
A core and satellite portfolio provides the best of both worlds. It makes it possible to have a core portfolio that helps fulfil our goals, and a satellite portfolio can enhance the returns and help us reach financial goals faster. Moreover, your core portfolio will be insulated even if the satellite portfolio doesn't work as expected. It is okay to move some of the gains from the satellite portfolio to the core portfolio, but it shouldn't ideally be the other way around. It is better to segregate the core and satellite portfolios clearly.
Padmaja Choudhury is a freelance financial content writer. With around six years of total experience, mutual funds and personal finance are her focus areas.