Portfolio Ideas. The right way to chase higher returns

How do you build the ‘satellite’ when you adopt a core-satellite portfolio framework? A satellite portfolio isn't your main tool for life-saving; instead, it is a smaller folio intended to capture short-term trends in the market. In this article, we discuss the investment products that can be of use in your satellite portfolio and how you can manage it.

You should only have one satellite portfolio. This portfolio has two objectives. The first is to generate excess returns (alpha returns) over an appropriate benchmark index in the equity market. This objective is complementary to core portfolios that focus on achieving only market returns (beta) to achieve life goals. The second objective is to capture short-term price movements in financial markets. Listed below are some of the investment products you can use in your satellite portfolio.

Exchange-traded funds (ETFs), a good fit for the core portfolio, are typically passively managed by asset management firms. You can actively trade ETF units on the stock exchange. An ETF contains a basket of securities just like an index fund, but offers an opportunity to generate short-term gains at a lower cost.

Then there are style-specific active funds — mid-cap or sector-specific — such as an FMCG fund. Suppose the mid-cap index generates an annual return of 15 per cent. If your investment in a mid-cap active fund generates 18 per cent, the alpha is 3 percentage points.

For your commodity investments, consider gold ETFs. This is because financial gold is more liquid than physical gold.

Moreover, the objective is to profit from short-term price movements in gold, not buy jewellery. If you are comfortable with the derivatives market, you could consider commodity futures on crude and silver, for example.

You need a disciplined approach toward buying and exiting satellite investments because the intention behind this portfolio is to capture alpha returns and short-term gains.

One approach is to use technical analysis to enter and exit your investments. This would work well for your investments in equity ETFs, gold ETFs and commodity futures. You should, however, strictly apply your stop-loss rules to prevent sharp erosion in your trading capital.

The question is: can you read the charts and take decisions? If not, you can subscribe to technical analysis reports published by professional traders. Technical analysis of style and sector indices can also be helpful in buying and exiting active style funds and sector funds. If you are uncomfortable using technical analysis, you should adopt a rule-based approach to enter and exit your satellite investments.

A simple approach would be to buy ETF units every week for a pre-determined value, say ₹5,000. The exit should be based on pre-defined profit-loss rules. You may, for instance, decide to take profits if the unrealised gain is 10 per cent or more. You should also exit when the unrealised loss is above a certain threshold percentage. The typical gain-loss ratio is 2:1. That is, for every 2 per cent expected gain, you should not risk more than one per cent loss. So if you decide to have a 10 per cent profit rule, your loss rule should preferably be 5 per cent.

The satellite portfolio is important for two reasons. One, concentrating only on your core portfolios would result in missing out on opportunities to capture market gains, as core portfolios focus only on generating market returns.

Two, it is emotionally fulfilling to have a portfolio for capturing short-term price movements without compromising on longer-term life goals.

Finally, remember this: you should have a sound process if you want to improve your chances of generating consistent returns in your satellite portfolio.

The writer is the founder of Navera Consulting. Feedback may be sent to portfolioideas@thehindu.co.in

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