How to build a core and satellite fund portfolio


Annalisa Esposito, Data Journalist, Morningstar UK  |   18th Dec 2020  |   6 min read

The ‘core and satellite’ approach is a solid way to construct your investment portfolio, but it’s important to consider risk and fees.

Building an investment portfolio is not an easy task. Whether you’re a novice or a skilled adviser, picking the right funds takes time and research and, despite that, many times we all get something wrong.

One approach investors can take is to build a core and satellite portfolio. This strategy can help to spread investment risk without overly limiting your returns. The core, or centre or your portfolio, is allocated to investments that should deliver steady returns, while the satellite portion incorporates smaller investments in more specific funds in which you have a strong belief. You might, for example, want a technology fund that taps into the big tech stars of the future, or a commodities fund that will seek out oil and mining companies.

Because these satellite funds are more specific in their focus – and may be riskier in their choice of assets – you may consider putting only a small proportion ofbyour money in them, leaving most of your allocation to core funds. “Building the right portfolio is all about striking a balance between growth and risk,” says Darius McDermott, managing director at Chelsea Financial Services. “You need your pot of money to grow enough to achieve your financial goals, while also being comfortable with the level of risk you’re taking to succeed in that aim.”

1. How to pick a core fund
Core funds, as the name suggests, form the heart of your investment portfolio. It is the main building block around which to construct your satellites. Core funds are solid performers, those that deliver regardless of stock market conditions.

They are often low-volatility or passive options that track major market indices, such as the S&P 500, FTSE All-Share or Global Bonds, or multi-asset ETFs which provide exposure to a range of asset classes. Choosing a tracker fund as the core of your portfolio is a great way to keep costs down.

But investors may also select an actively managed fund for their core. Morningstar analysts’ favourite core funds include Gold-rated Greencap Broadcap, Gold-rated T. Rowe Price Global Equity and Silver-rated PIMCO Global Bond.

Several active managers now also offer access to their strategies via the exchange (exchange quoted managed fund – or active ETF) like Magellan, Platinum, Fidelity, ActiveX, Pinnacle and Schroders. This takes away the mountain of paperwork required by traditional unlisted managed funds and removes restrictive minimum initial investment requirements.

A core fund may have a global mandate to provide diversification, says Mark Preskett, portfolio manager at Morningstar Investment Management (MIM). Or it may have a “home bias”, focusing on the market where you live. “The key is that they outperform the market, while keeping their tracking error low,” Preskett adds.

2. How to choose satellite funds
Satellite funds are the additional positions you can use to build on your core and help to strengthen your returns. These may be more volatile options, perhaps in riskier or niche areas.

“They will generally make up a smaller proportion of your portfolio but can help you take advantage of more exciting or riskier opportunities without putting your entire investment port in too much jeopardy,” says Chelsea’s McDermott.

There are different ways to select satellites funds. Preskett looks for good valuations and reasonable fundamentals and has recently invested in funds focusing on energy, Korean equities and Mexican stocks, for example. He adds: “Small-caps, high-yield investments and emerging markets are all areas which could be satellite investments. It’s a good way to get exposure to out of favour markets.”

Satellite funds can also be a way to express your own interests or macroeconomic views. For instance, you may believe the gold price has further to climb, or perhaps you want to tap into trends such as cybersecurity or the shift to a cashless society.

Examples of supporting players Morningstar analysts rate highly include the Goldrated Pendal Small Companies, Gold-rated Platinum Asia, Silver-rated GQG Partners Global Equity and Gold-rated Vanguard Index Australian Property.

3. Don’t forget fees
While a core fund holding may stay in your portfolio for many years, a satellite fund may have a shorter shelf life. Preskett says that while it is OK for these investments to be tactical, investors should avoid trading too regularly or trying to time the market, not least because it adds to your costs.

“Investors are often attracted to the latest ideas and fads, often because they have had a recent bout of strong performance,” Preskett says. “This may mean you then invest in a volatile market after it has already risen, and that could come back to bite you.”

Bear in mind fees, too. Niche funds may often have a more expensive price tag than a plain vanilla option; and when choosing your satellites, remember: the higher the fee, the greater the returns you need to make an impact.

The key to the core-and-satellite approach is to find the right balance between risky and less risky options for your own investment needs. “Keep your satellites as satellites, a small portion of your portfolio,” says Preskett. “Without the proper research it’s easy to get into trouble, but by being sensible this approach can reap rewards.”

Adviser Research Centre users can access the Fund screener tool HERE.

With this tool Advisers can search on Morningstar Analyst rated funds and determine what type of fund they are looking for eg, Core or Satellite to aid in portfolio construction.

Morningstar Analyst Rating is based on interviews with management and fundamental analyst research on the people, process and philosophy, the Morningstar Analyst Rating reflects our analyst insight and opinion on the capabilities of the strategy moving forward from today .Analyst conviction is summarised on a five-point scale. Gold, Silver, Bronze, Neutral, and Negative. Gold rated funds are funds have our highest-conviction recommendations and stand out as best-of-breed for their investment mandate.

The “Research Flagship Fund” is the primary share class that analysts in Australia and New Zealand rate. The other vehicles are typically called siblings or platform funds.

Role in Portfolio – A guide to assist with portfolio allocation, funds can be designated core, or supporting. Core funds should be the bulk of an investor’s portfolio, while supporting players contribute to a portfolio, but are secondary to the core.

 


Original article “Investing basics: how to build a core and satellite fund portfolio” can be found here.

Originally posted 2020-09-24 15:03:02.

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