Active or Passive? Why not do both with a Core-Satellite approach?
One of the best strategies for building long-term wealth such as superannuation, is to implement a Core-satellite approach. This strategy recognises the fundamental importance of asset allocation for long-term portfolio results by blending both passive and active investments.
How a core-satellite strategy works is that your investment portfolio (super fund asset allocation) is divided into two parts; a main part, aptly named the core which is the lower cost passive strategy, and a smaller part called the satellite, which is the more expensive active strategy.
The core makes up approximately 80-90% of the total portfolio and is typically made up of index funds that simply track an index or follow the market.
The primary aim for an index fund is to track market performance (beta) at a low cost to an investor. Index funds achieve this by holding a broad spread of securities within an index with an aim to track the overall performance of the index. An index fund does not require the same level of research and security analysis that active management requires (which is a substantial cost) and will tend to buy and hold these securities with very low levels of portfolio turnover. Lower portfolio turnover results in lower fees to the investor and generally more favourable tax outcomes.
The satellites make up the remaining 10-20% of the total portfolio and are invested with the idea being to find and exploit inefficiencies and to outperform or beat the market (alpha).
A core-satellite approach is a common and time-tested investment portfolio design that’s proven to be a great way to focus on long-term capital growth, while still allowing for the opportunity to increase returns through active portfolio management.
- John Pearson