Sun. Dec 3rd, 2023
The Core-Satellite Investment Strategy: Merits and Shortcomings

Many investors utilize the core-satellite investment strategy to construct their portfolios. This approach involves investing a majority of capital in a few key funds, alongside smaller positions in funds that focus on niche areas or shorter-term assets to potentially generate alpha.

Wealth managers emphasize the merits of this strategy, particularly its ability to enhance returns while lowering volatility through portfolio diversification. By balancing different investment styles and strategies, investors gain flexibility and reduce the inconsistency of timing markets or relying on specific managers.

Another advantage of the core-satellite strategy is its potential to prevent frequent portfolio adjustments, as the core element is focused on long-term investment. This approach also allows investors to keep overall portfolio costs low, as the core typically consists of passive funds with lower fees.

However, the satellite components of the strategy may not always generate the desired alpha and can even result in losses. This can lead to an underperforming portfolio if the core elements fail to compensate for the losses caused by the satellite funds.

When building the core part of a portfolio, investors should consider investing in more mature companies and industries to provide stability. A typical core fund can be passive or a style-agnostic active fund seeking to generate alpha over time, although the latter category is becoming rarer due to the rise of passive investments.

Satellite funds, on the other hand, represent higher risk investments and can focus on less efficient markets, specific sectors, or particular investment styles. These funds can be used strategically for long-term alpha generation or tactically to take advantage of short-term market opportunities.

The allocation of core to satellite holdings varies, but the general recommendation is to allocate a larger portion to the core. Some wealth managers suggest a 60-70% allocation to the core with the remaining difference in satellite funds. However, others propose an even higher emphasis on the core, with around 75% allocation, to ensure long-term returns are maximized.

Investors should also consider their level of involvement in managing their portfolios as satellite funds often require closer attention in niche areas. The number of satellite funds an investor holds will determine the amount of time spent monitoring the portfolio.

In conclusion, while the core-satellite investment strategy has its merits in diversification, enhanced returns, and cost management, investors must carefully assess the performance potential of satellite components to ensure a balanced and successful portfolio.