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The core-satellite approach: Minimising costs and maximising your investment returns.

Updated: Apr 5

Investing in the stock market can be a tricky business, especially if you are just starting out. With so many stocks to choose from and a seemingly endless stream of information, it can be difficult to know where to start. But did you know that the most important aspect of investing is not necessarily selecting the right stock, but rather your portfolio construction and asset allocation?


Studies conducted by Brinson, Hood and Beebower have shown that asset allocation accounts for 94% of the variation in portfolio returns, with the remaining 6% being attributed to market timing and security selection. This highlights the importance of getting your portfolio construction right, and one way to construct your portfolio is using the core-satellite approach.


The core-satellite approach: Minimising costs and maximising your investment returns | Stock Analysis | The Globetrotting Investor
Variation in portfolio returns

So, what is a core-satellite portfolio?


The core and the satellite are two components of a core-satellite portfolio.


The core component of the portfolio typically consists of broad-based, passively managed investments that provide a foundation of stability and diversification to the portfolio. This typically includes low-cost index funds or ETFs that track a broad market index such as the S&P 500 or the MSCI World. The objective of the core component is to provide exposure to the market as a whole and to generate returns that are in line with the overall market.


The satellite component of the portfolio, on the other hand, consists of actively managed investments or individual securities such as stocks or bonds. The objective of the satellite component is to generate returns that are higher than the market average. The satellites can include individual stocks, actively managed funds, or other types of investments that have the potential to generate higher returns than the core component.


The allocation of what constitutes a core, or a satellite is subjective and will vary depending on your risk tolerance, individual goals, life stage, and the length of time you wish to hold the investments.


The 8 benefits of adopting a core-satellite approach.


The idea behind the core-satellite approach is to take advantage of the benefits of passive investing while reserving a portion for more active investing. These are the 8 main benefits of adopting a core-satellite approach.


Increased Portfolio Diversification: By splitting the portfolio into passive core and active satellites, the core-satellite approach can provide a broader diversification than relying on individual stock picks. This can help reduce the overall risk of the portfolio.


Improved Investment Control: The core-satellite approach gives investors more control over the composition of their portfolios. Investors can choose the components of the core based on their long-term investment goals, while the satellites can be adjusted to respond to market changes, economic trends, and other short-term factors.


Tax Efficiency: Index funds or ETFs, which are typically used as the core component of a core-satellite portfolio, have low turnover rates and are more tax-efficient than actively managed funds. This can help reduce the tax impact of your investments over the long term.


The core-satellite approach: Minimising costs and maximising your investment returns | Stock Analysis | The Globetrotting Investor
Source: https://www.dontmesswithtaxes.com/

Flexibility: The core-satellite approach is flexible and allows investors to adapt to changing market conditions, investment opportunities and even life stages. The passive core can provide stability and consistent returns, while the active satellites can be adjusted to respond to new opportunities or changing market conditions.


Low Cost: One of the primary benefits of using index funds or ETFs as the core component is that they are typically low cost. By keeping the core of the portfolio passive and low-cost, investors can reduce the overall costs of their portfolio and improve long-term returns.


Better Alignment with Long-Term Goals: The core-satellite approach aligns with the idea that asset allocation is the most important factor in determining the success of a portfolio. By keeping the core of the portfolio focused on long-term goals and passive investments, investors can reduce the potential impact of short-term market movements and stay focused on their long-term goals.


Improved Risk Management: The core-satellite approach can provide improved risk management by reducing the overall reliance on individual stock picks. By having a well-diversified core, investors can better manage their overall portfolio risk.


Increased Potential for Above-Market Returns: While the core component of the portfolio produces “beta” or market returns, the active satellites can produce “alpha” or above-market returns. By actively investing in individual stocks or other investment opportunities, investors can take advantage of market inefficiencies and undervalued opportunities.


The bottom line


The core-satellite approach is a flexible and effective way to construct a well-diversified portfolio that balances long-term stability with the potential for above-market returns. By combining passive investments with actively managed investments, investors can improve their chances of success and better achieve their investment goals.




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