Personal Finance

Explaining core and satellite portfolio strategy

Keerthi Sanagasetti BL Research Bureau | Updated on July 10, 2021

It aims to optimise costs, taxes and risks in the overall portfolio

A coffee time conversation between two colleagues leads to an interesting explainer on a portfolio construction strategy.

Vina: Did you hear about Meena making windfall gains through her smallcase investments? Makes me want to try my hand at it too. I felt exactly the same way when cryptos rallied last year. I think it is some kind of FOMO playing out!

Tina: Relax Vina. It is not like she has got the Midas touch when it comes to investing. You can also up your game by venturing into other asset classes. But be mindful of the risk you undertake. I hope you know that every asset class that promises you superior returns comes attached with equally superior risks too.

Vina: Agreed! But isn’t there a way out. I mean, what is one to do if one wants to generate better than market returns, and at the same time contain the risks.

Tina: Have you heard of the Core - Satellite portfolio strategy? It is a strategy that aims to optimise costs, taxes and risks in the overall portfolio while aiming to maximize returns. May be this approach could help you address your FOMO.

Vina: I assume, the core is the main portfolio. But, what is the satellite portfolio? Does it keep revolving around the core? Like the Moon around planet Earth?

Tina: No Vina. This strategy works as follows. The core portfolio is made up of funds or other investments that aim at acheiving one’s financial goals --- be it through debt instruments (sovereign or otherwise), funds (ETFs or index funds) and other assets that essentially help cut down on costs and volatility in the long run. For longer tenure portfolios, gold can also form part of the core portfolio. The smaller satellite portfolio is one where you can try your hand at actively-managed riskier assets for alpha generation. One can also use his / her satellite portfolio for saving taxes by investing in equity-linked savings schemes or ELSS. Depending upon one’s goals and the risk associated with the stock picks, direct equity investments can either be part of your core or satellite portfolio.

Vina: Why two portfolios? How does that help?

Tina: While the core helps in generating the minimumreturn required to meet one’s goals according to one’s risk appetite, the satellite portfolio adds extra spice to these returns. This is definitely better than burning one’s fingers by investing the entire corpus in risky assets, all in the name of seeking alpha.

Vina: Fair point. What is the ratio in which I should split my portfolio into core and satellite, then?

Tina: While there is no one size fits all approach, most experts advise a 70-80 per cent allocation to the core portfolio. The ideal ratio depends on the type of assets added to your satellite portfolio and the amount of risk they would add to your overall portfolio. The idea is to earn the minimum return to meet your financial goals through your core portfolio investments. One’s satellite investments can range from credit risk funds to thematic or international mutual funds to direct investments in equity. Some also prefer to add alternate investments such as REITs/InvITs, PMS, private equity (including pre-IPOs) and even cryptos to their satellite portfolio. Whatever the asset class(/es) you choose, the losses if any, should not eat away too much into your overall portfolio return.

Vina: Right. Simply put, this strategy seems like a fair way in which one can try to get the best of both worlds, superior returns with a cap on the downside risk.

Published on July 10, 2021

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