Tuesday, October 19, 2021

Introducing You To Core-Satellite Approach of Investing

While looking for investment suggestions and strategies, one can often land into an unending sea of vast information and techniques. And we have always endeavored to provide our readers, in-depth and relevant information on all subjects on money matter, in the easiest way possible. In our previous articles, we have covered investing using techniques of diversification, talked about the beginner’s guide to stock market investment, gave you an insight into the portfolios of billionaires like Bezos and Gates, and covered a wide range of knowledge on cryptocurrency investment.

This time, we are going to discuss another fascinating investment strategy that has been around for quite some years now- The Core-Satellite Investing Methodology. To define the core-satellite investing technique in the simplest terms possible, we can name it ‘the low-risk technique’ with a very long-term approach.

Core Satellite Approach of Investing- Uncut Globe

So what exactly is Core Satellite Investing methodology?

What is Core-Satellite Investing Approach?

It is a method of investing in which a ‘core’ part of the portfolio is created by inculcating index funds such as the S&P 500 Index fund. They are meant to monitor and follow the market return in a passive manner. This core usually tends to hold the majority of your asset allocation- around 50 percent of the investible value should go into these passive funds. Branching out from the ‘core’, are the ‘satellites’ which are meant to take a bit more aggressive positions in high-yielding bonds and equity stocks that can improve the alpha of a portfolio.

The fundamental behind using the core-satellite approach of investing is to reduce tax liability and other expenses, while over-performing market indices at the same time. It helps to distribute assets in such a way that a suitable mix of actively and passively managed stocks can co-exist in tandem, allowing the investor to make certain sector plays that might not be available if one chooses to hire a Financial Advisor.

Essential Benefits of the Strategy

The key considerations for using this strategy are three-fold:

1.     Minimization of cost

The Core consists of index funds that follow overall market participants in that index and thus there is a motivation to change from value investing to growth investing. And, since index funds do not change unless underlying companies change, it is suggested to hold them for the long-term. This minimizes tax liability on capital gains and helps avoid broker commission expenses and other transaction costs. 

2.     Management of Risk

Since a large portion of the portfolio is dedicated to index funds that tend to have low to moderate risk, the Beta (or market risk) is usually kept in check and thus minimized. 

For instance, a Beta value of 1 means that the investment is strongly related to the market. The stock has an inherent systematic risk, but is not volatile in terms of unsystematic risk.

3. Over-performing the market return

The asset allocation in the ‘satellites’ tends to focus more on active management coupled with aggressive investing. This aims to earn a higher than the market rate of return while managing higher risks as well. However, the lower Beta of the ‘core’ manages to keep the overall portfolio Beta under check. 

Action Step- How to begin with core-satellite approach of investing?

We understand that the plethora of information available on the internet is hard to provide a direction to begin with any investment strategy for that matter.

So in order to help you make full use of the information, I will for every subsequent article which may require, include a section called the ‘Actions Step’. This will allow readers to start taking real steps towards financial freedom.

Suppose you have a fund of $10,000 that your grandmother gave you on your last birthday. You stumble upon this article and want to make grandma proud by saving and growing the money she gave you. Maybe you can buy her something nice from the profits you make.

Well, here is a sample portfolio utilizing the Core-Satellite Approach

S&P 500 Index has given a return of 3.21% Year-To-Date (YTD). So, you can put $5000 of that fund into S&P 500 Index. It is a type of Mutual Fund or ETF that you can buy in units from any brokerage house like Robinhood and Fidelity.

You can put the other $5000 in actively managed bonds and equity shares. But remember, diversification within these satellites is important as well. The Beta of the portfolio must be kept at an acceptable level depending on each investor’s risk taking-capability.

Hope it helps you to form a better, stronger and safer portfolio.

Rahul Sinha
Rahul is a B.Com(Hons) graduate from Delhi University and a CA final candidate. He is also the co-founder and CFO of a healthcare start-up based out of New Delhi, India. Rahul is an avid investor and holds a diverse portfolio. Having worked for 3+ years with Deloitte in Statutory Audit and then later in a tax profile, Rahul believes in understanding the bottom-up functioning of established businesses and leverages this very knowledge to create value through his company. His next challenge lies in Germany where he will soon be pursuing his masters degree in Finance.





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