Core-satellite is a common-sense investment approach typically comprised of a passive core of broadly diversified investments combined with actively managed satellites.
A core-satellite approach can help you build a trusted, values-based relationship with your clients, while encouraging them to take a long-term view of their wealth.
One important advantage of a core-satellite approach is the seamless way it allows advisers to talk about portfolio construction concepts with clients in a way that makes them feel more in control of their investments.
So what’s the best way to start the core-satellite conversation? Here are a few tips.
Focus on the power of passive and the advantage of active
When discussing investment styles with your clients, the question of active versus passive inevitably arises.
Your client may prefer a passive approach, or they may be comfortable adopting more of an active stance to benefit from potential alpha-generating opportunities.
Core-satellite makes room for both styles, understanding that the right mix of passive and active investments can support your client’s goals.
Rather than present active and passive as two opposing styles, talk about how they can complement each other in a well-constructed portfolio by adding greater style diversification, providing exposure to active opportunities, and anchoring performance in a strong and steady core.
Talk in terms of building blocks
Managed funds and exchange traded funds (ETFs) are ideal building blocks for a core-satellite portfolio. By offering scale and transparency, they also help your clients understand how their portfolio is constructed and which sectors, styles, and regions they’re exposed to.
Index managed funds and ETFs provide a way to gain instant, broad market exposure. Index funds are known as ‘passive’ investments because they aim to match market returns by tracking a particular share or bond index.
For your clients, the key points to understand are that most index funds have historically delivered competitive long-term performance at a low cost. Due to their inherent properties as highly diversified, low-cost investments tracking market performance, index funds are the conventional choice for the core of a portfolio.
Typically, high-quality index funds will make up the core of your client’s portfolio, but certain index funds may also be useful as satellites.
In contrast to passive index funds, ‘active’ funds aim to beat the index over time. While active funds may be riskier than passive index funds, their potential for higher returns can make them an attractive proposition for your client’s portfolio satellites.
Lay the foundations with a high-quality core
The core is typically where most of your client’s investments are allocated, which means it’s arguably the most important part to get right.
For many investors, the core of the portfolio will aim to provide broad exposure to investment markets and is typically made up of low-cost, highly diversified index funds. The passive core typically:
• Seeks market returns.
• Keeps investment costs low.
• Has lower manager risk.
• Takes a long-term focus.
• Has high potential tax efficiency.
For your clients, the purpose of the core is to provide stability with an asset allocation that’s suited to their risk and return objectives. Its helpful to frame the core as the component of the portfolio that doesn’t get adjusted in response to short-term market conditions, but rather stays aligned to your client’s long-term objectives.
Emphasise the importance of manager selection
The core-satellite approach offers no firm rules about what investments should comprise the satellites.
Typically, however, the satellites are an opportunity to add specific investments that are of interest to your client, or to take advantage of active management styles.
By adding active investments as a complement to a passive core, your clients can tilt their portfolio towards a particular sector or high-conviction style, or manage a certain objective such as outperforming the broad market.
When discussing active management satellites, it’s critical to focus on manager selection. The foundation of active management allocation often rests on three key pillars: talent, cost, and patience.
The first pillar – talent – is about choosing a manager with proven experience and demonstrable investment abilities. They should clearly articulate what their investment philosophy is and display the ability to execute on processes that hold up to the test of time.
The next pillar – cost – is critical in the world of active management. Actively managed products often come with higher fees compared with index products, which can eat into performance. Avoid overpaying for active products by tracking the costs associated with the strategy and comparing with similar managers.
And the last pillar – patience – while easily understood, is probably the most important aspect. Like most things in life, good things come to those who wait, particularly during periodic bouts of market volatility. The benefits of a lower-cost active fund run by a talented manager are easily eroded if you or the manager constantly react to short-term noise.
Stay the course
The core-satellite approach recognises that the most important investment decision your client can make is how they allocate their money across different types of assets and staying invested for the long-term.
Once your client’s portfolio is constructed, a core-satellite approach can make the portfolio review process more efficient. Fewer satellites should mean less time required to monitor active funds for team and performance differences.
Market ups and downs are a natural part of investing. For your clients, the emotional side of investing can be just as important to manage as their portfolio.
When you talk with your clients, be sure to check in on how they feel, validate their emotions, and keep them focused on their long-term objectives.
Get more from your core with Vanguard. Find out more about Vanguard’s core ETFs and managed funds.
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