A core & satellite portfolio is a proven strategy for an effective allocation of your assets. Here your long terms goals are clearly listed down and the asset selection is based on achieving them. But many a times the portfolio creation is difficult for investors. With so many choices and less awareness, analysing which investment should come under core and what should satellite comprise is a tough task. This results into mistakes such as overinvesting in a particular asset class. I have discussed here the allocation of core portfolio since it is more important for your goals.
What is a Core?
A core in your investment portfolio is the base of your investment. They are not meant for changing frequently and so comprises of long term investments. These will be lesser volatile when you hold them for the term and will offer you consistency in returns with some downside protection. A core will have the maximum allocation in your investments. Although there is no defined formula to calculate core exposure, it should be at least 50-60% of your total invested portfolio. The exact allocation will vary with the time horizon of the goal you want to achieve and your risk appetite.
Contrary to this in the satellite portion of your portfolio you invest in more volatile categories where the probability of generating higher returns is more and you may have to manage it more aggressively to meet the desired objective.
What Comprises Core?
So when we have identified that core should comprise of long term investments, the larger question to an investor is which are those. Even in long term there are different categories.
The main criterion for searching a core investment is that it should not give you sleepless nights. You are more concerned with consistency and so are not targeting very high returns. You should be able to earn enough to beat inflation and which can help you in meeting your goal. You will not be interested in churning this part of portfolio unless for reason such as underperformance.
Here are few options which can be included in the core of your investment portfolio:
1. Large Cap Equity Funds– This category generally comprises of stocks of companies which have a slow growth but consistent and so are considered to be low on volatility as compared to smaller companies. They offer some downside protection to investors during market downturns. Due to these investments, Large Cap Equity Funds becomes an ideal choice when you are creating a core portfolio. Even in large cap categories there are funds which will have focus on specific list of large cap stocks while others will have a larger range. They can be part of core portfolio but ensures the difference in risk is understood and wiser to have both the categories.
2. Balanced Funds: Hybrid funds which have 65% & more exposure in equities are also a good choice. These funds, due to debt exposure up to 35%, offer downside protection to your investments along with generating returns from equities. Within these one should compare the inherent portfolios and then make a selection.
3. Dividend Yield Funds: These types of funds invest in companies which are consistent in dividend payment to their shareholders. In such companies the growth year on year is clearly visible and they are able to generate cash surplus consistently. They will be low on debt which helps them in rewarding shareholders by paying them dividend consistently. This inherent investment makes these funds a good choice for including in a core portfolio.
4. Bond Funds: A core portfolio is not only made through equities but should also comprise of debt category which is considered to be low on volatility when held for the term. Long term debt mutual funds such as income and gilt are able to offer the characteristics required in a core portfolio. They will not produce higher returns but decent enough to beat inflation and take care of taxation along with managing consistent performance. An inclusion of debt funds gives a much needed diversification to your core portfolio.
Investors who have an inclination towards stocks should ensure their core portfolio comprises of blue chip companies which may not excite them but offer consistency and downside protection. From debt category PPF & EPF can also be part of your core investments.
How much core you should have?
There is no fixed formula for creating a core in your portfolio. It can be as high as 100% or you may have 60-70%. Much depends on the time horizon of your goals and your own risk appetite. If you are comfortable with experiencing a higher volatility you will be eager to add high growth funds in your portfolio. But ideally one should have always at least 50-60 % of their investment portfolio made of core assets. A satellite portfolio is generally meant for diversification. They have capability of delivering higher returns but are associated with high volatility. Also, it’s a more tactical allocation where you may have to change the portfolio frequently based on market scenario. The exposure to this part of portfolio should be allocated only when you have analyzed your risk tolerance and goals. But avoid going beyond a certain limit to ensure achievement of your long term goals.
A core portfolio is a backbone of your investment. It is the basis on which achieving your long term goals rest. While creating your investment portfolio the formation of core should take place first and then the diversification can happen later.