Core and satellite – creating a balanced investment universe
There is an approach to building your investment portfolio which is called core-satellite investing. At its simplest of course this means that there is a core of investments around which other investments circle – the satellites. The core investments and the satellite investments complement each other.
There are varying interpretations of the core-satellite approach to investing: what makes the ‘core’ of the investor’s portfolio is a matter of preference, depending on attitude to risk and time horizon. And arguably what makes the ‘satellite’ is again dependent on circumstances.
A common core-satellite approach is to have a passive core based on a market index, gilts, bonds etc supplementedby actively-managed satellite investments.
However, it is very important not to take the passive feature too … well, passively and not to be afraid of adding some active management to a portfolio. While some people advocate passive for core; competitively-priced active core funds such as Alliance Trust at least offer the potential for outperformance whereas passive funds normally underperform theirbenchmark after costs.
Alliance Trust provides a solid core equity investment vehicle for aportfolio, securing capital growth and rising income and around which the investor can build a universe of other satellite holdings, be they other investment trusts, Oeics, ETFs in regions, sectors and industries to complement the stocks within the investment trustat the core.
The average tracker fund may hold more stocks but, like a tracker, Alliance Trust covers most parts of world equity markets while being highly selective about what it owns.
An additional diversification positive is that Alliance Trust itself invests across countries, sectors and a range of investment styles.
Other asset classes investors may want to hold, for example, bonds, property, alternatives etcwhich can be accessed through othersatellite to create a fully diversified portfolio.
Underlying this core-satellite approach is – as should be the case with all investment – the reason for investing. What are your financial goals and how can you achieve them in the most cost-efficient way?
Dennis Hall, Chartered Financial Planner at Yellowtail Financial Planning says that most people he deals with are thinking about retirement and needing a portfolio that will sustain them for 20, 30, 40 years.
“It is about understanding the growth you need to achieve the objective,” he says. “How would you invest for that? And as simply as you could, because charges are a very important factor? For our clients we want to create a core with as much predictability as we can find. So that leads to a core of globally diversified funds, predominantly equity but with a little bond investment in there as well. When we feel we have satisfied the ability to forecast an income stream from that, whether that is dividends or a combination of dividends and growth, to meet their spending needs over 30, 40 years, we might then look outside of that to have a satellite to that core.”
If a core holding is going to be a global equity fund, then Hall says you might want to look for holdings not captured in that sort of funds, e.g., private equity.
“I have a couple of private equity funds i.e., HG Capital trust and Pantheon – long satellite holdings of mine. But I am also looking for conviction managers, so instead of having 6-12,000 global equities in a fund, I might want a manager that has nailed their colours to the mast and has 25-30 stocks. I will use people like Terry Smith or Keith Ashworth-Lord, manager of theCFP SDL UK Buffettologyfund. But only about half a dozen funds form my satellites.”
Where should you be investing?
Justin Modray, director of Candid Financial Advice explains the core-satellite approach he advocates for clients in terms of striving to build portfolios that provide good, cost-effective, diversity and should weather most storms markets can throw at it.
“There is no such thing as the perfect active manager, all underperform at times, but combining those who appear skilled, and invest differently to the Index, with core tracker funds is a sensible hedge,” he says.
Modray typically uses index-tracking funds for core stock market exposure and augments with good actively managed funds that invest differently to the Index and cover other asset types such as fixed interest and infrastructure.
“We stopped recommending physical commercial property exposure several years ago due to the liquidity issues that the pandemic laid bare, using global property index trackers instead,” he said. “These tend to be more correlated to stock markets shorter term than is ideal, but still offer some diversification and avoid the liquidity issue. We shun absolute return funds as it feels a flawed concept, we doubt any manager possesses the required crystal ball to consistently deliver what’s on the tin.”
Modray agrees with Hall that when investing in stock markets he believes clients should always take a long-term view, at least five years preferably longer.
“Risk is usually the key determinant in the relative balance of stock market exposure relative to other assets like fixed interest, property and infrastructure,” he says. “The more comfortable a client is with risk, the more comfortable we are increasing their stock market exposure, including that in higher risk areas such as emerging markets and smaller companies.”
The core-satellite approach is really what the investor wants to make it, but the disciplines should be security and cost efficiency. But also, why not try something a little different if you want to?
Holly MacKay, founder and CEO Boring Money says: “I think many more experienced investors adopt a core/satellite approach for two key reasons. One is cost – in mature markets such as the US, is it worth paying above the odds or will a straightforward S&P tracker deliver a very solid building block? And another reason is interest – most hobbyist investors will have a thematic interest or a growth hunch about a sector or region to back, and so some smaller ancillary holdings ‘scratch the itch’ whilst a collection of solid core holdings provide decent foundations.”
The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. The views expressed were current as at April 2022 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is the appointed Alternative Investment Fund Manager of Alliance Trust plc. Alliance Trust plc is a listed UK investment trust and is not authorised and regulated by the Financial Conduct Authority
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