Core and satellite portfolio: What are they, how do they work, what should be the percentage allocated to each?

With a core portfolio, you can follow static allocation at the heart of your financial planning. With a satellite portfolio, you can follow tactical allocation to benefit from market opportunities.

When investing in mutual funds, different investors follow different styles of investing. One of them is the core and satellite portfolio method. In this article, we will understand what the core and satellite portfolio approach to investing is, how it works, and what the respective percentage allocation should be. 

What is the core and satellite portfolio?

The core and satellite portfolio is a method of investing which involves splitting an investor’s portfolio into two segments:

• Core portfolio: As the name suggests, this is the main part of one’s investment portfolio. Its performance has a very high impact on the performance of the overall investment portfolio. Hence, without it, achieving financial goals will be impossible.
   
• Satellite portfolio: The remaining portion of the portfolio, excluding the core portfolio, is the satellite portfolio. It forms a small portion of the overall investment portfolio. Its performance doesn’t have much impact on the overall investment portfolio.

How does the core and satellite portfolio work?

Now that we understand what the core and satellite portfolio is, let us examine how the investment strategy works.

1. Designing the core and satellite portfolio with equities
An investor can follow static asset allocation for their core portfolio. For example, for the equity portion, the core portfolio may be formed by investing in four index funds as below:

• One Nifty 50 Index Fund that gives exposure to India’s 50 largest companies
• One Nifty Next 50 Index Fund that gives exposure to India’s emerging 50 companies (ranked from 51 to 100 in terms of market capitalisation)
• One Nifty Midcap 150 Index Fund that gives exposure to India’s top 150 midcap companies in terms of market capitalisation
• One Nifty Smallcap 250 Index Fund that gives exposure to India’s top 250 smallcap companies in terms of market capitalisation

The above passive investment portfolio will give an investor exposure to India’s top 500 companies with zero overlaps. Also, investing through index funds has the benefit of diversification and a low expense ratio.

An investor can follow the tactical asset allocation for their satellite portfolio. For example, for the equity portion, the satellite portfolio may involve investment in sectoral funds, thematic funds, smart-beta funds, etc. The choice of funds is dynamic and depends on which sector/theme is doing well at that point in time.

Also Read: What Are Thematic Funds?

2. Designing the core and satellite portfolio with fixed income
For the debt portfolio, an investor’s core portfolio may consist of investments in Employee Provident Fund (EPF), Public Provident Fund (PPF), bank fixed deposits, debt mutual funds (liquid funds, money market funds, short-duration funds, etc.), etc.

For the debt portfolio, an investor’s satellite portfolio may consist of investments in corporate fixed deposits, non-convertible debentures (NCDs), fixed maturity plans (FMPs), etc. They may also consider investing in alternative investment products such as peer-to-peer (P2P) lending, lease financing, invoice discounting, etc.

Also Read: P2P Lending: Have You Explored This New Investment Option?

What should be the percentage allocation to the core and satellite portfolio?

The percentage allocation to the core and satellite portfolio may be determined based on an investor’s risk profile as follows:

• Aggressive: An investor with an aggressive risk profile may do a 70:30 allocation to the core and satellite portfolio. Please note, this is just a rule of thumb. An investor may go higher with a 75% allocation to the core portfolio or lower with 65%. The remaining allocation will be towards the satellite portfolio.
• Moderate: An investor with a moderate risk profile may do an 80:20 allocation to the core and satellite portfolio. However, this is not set in stone; the percentage allocation to the core portfolio may be higher or lower.
• Conservative: An investor with a conservative risk profile may do a 90:10 allocation to their core and satellite portfolios. In this case too, the percentage allocation to the core portfolio may go up or down.

Why should an investor follow the core and satellite portfolio approach?

As an investor, you might have a core investment philosophy. You can use it to design your core portfolio. However, from time to time, you will come across investment products that are not a part of your core portfolio but are doing well. You will get tempted to invest in them, although for a short period. However, you cannot afford to pull money out of your core portfolio to invest in these products. Hence, these products can be a part of your satellite portfolio.

The core portfolio is the key to achieving your financial goals. If the satellite portfolio does well, it will help you reach your financial goals faster. However, if your satellite portfolio doesn’t do well, it won’t hamper your core portfolio and hence won’t impact your financial goals negatively.

Actionable insights

When you start investing towards your financial goals, assess your risk profile.
Accordingly, decide the allocation between the core and satellite portfolio.
Choose the financial products to invest in as part of the core and satellite portfolio, and go ahead with the investment.

Review both portfolios from time to time and take corrective action whenever required.