Investment markets can move significantly in unpredictable ways and experience tells us that selecting managers that consistently outperform the market is a challenge.
The core-satellite approach to portfolio construction uses index funds as the stable "core" of the portfolio, with carefully selected lowly correlated active investments as the "satellites."
Active managers/Direct investment (satellite)
Index investment (core)
Note: Asset allocations in this diagram are intended to be an example only and not a recommendation.
The key benefits of using index funds as the "core" of a portfolio
Cost advantages: Lower management and transaction costs.
Diversification: A broader spread of securities which means less exposure to the performance fluctuations of single investments.
Ease of management: Indexing provides consistent performance resulting in greater stability of your portfolio, making on-going portfolio management much easier.
Tax efficiencies: Index fund managers typically turn their portfolios over less often than active managers.
Risk control: Consistent returns mean a low level of volatility.
Implementing the core-satellite approach
To effectively design and implement a series of core-satellite portfolios the following factors will need to be taken into consideration:
Determine the risk profiles and strategic asset allocation.
Determine the investments for the core.
Determine the size of the core versus satellite in each asset class.
Determine how many active satellites are to be used and which ones to complement the core.
Asset allocation decision
Seeks market performance
High potential tax efficiency
Index & Active
Asset class returns plus some opportunity to outperform
Seek to outperform the market
Offers concentrated and style-driven strategies
A core-satellite approach allows businesses to lower overall client investment costs, and in many cases enhance practice profit, while providing clients with greater consistency of results. Once implemented, the approach is easily managed, giving you time to concentrate on the important things in your business.
Many leading financial planning practices have embraced a core-satellite approach into their business model.