Most investors know not to put all their eggs into one basket, but how about one medium-sized basket and a number of smaller, flashier baskets? The Core and Satellite approach is a clever combination of the two primary approaches to investment management: active and passive investing.

Passive management is a strategy followed by investors who believe that in principle markets are efficient and that it is not possible to outperform the market consistently after allowing for the risks taken on. In practice this approach involves investing in an appropriate index fund or a suitable, low-risk unit trust that closely follows its benchmark. These investors will never outperform the market or the stated benchmark, but management fees are very low and the portfolio will at least keep up with market returns.

In contrast, active investors believe that market inefficiencies can be exploited to achieve returns in excess of their benchmark or market indices. Active managers invest into assets that are undervalued in an attempt to make a profit as the market eventually corrects for the mispricing. Investors are able to outperform market indices or other benchmarks over time, but only if competent managers making the right investment decisions are selected. The negative to active management is the higher cost when compared to the passive management.

The Core and Satellite then is a blending of these two methods in order to achieve the best of both worlds – the possibility of outperformance at a lower overall cost.

Using this methodology, the Core portfolio forms the foundation of the total fund, and should be positioned to achieve stable returns at relatively low risk. It will usually comprise 40% - 60% of the total portfolio and in order for the overall strategy to be successful, the Core portfolio should have as low an overall cost as possible. Investment into a selection of index tracker funds or enhanced tracker funds should typically achieve this objective.

The Satellite portfolios are smaller amounts allocated to specific active investments, added purposely to enable the total portfolio to outperform its benchmark. These portfolios should be managed by skilled active managers who are able to outperform their benchmarks by investing very differently to the benchmark. Managers with different styles, e.g. value or growth, can be selected, as well as different themes such as commodities, emerging markets or small caps. It is important that these managers are aggressive enough in their approach to justify their higher management fees.

The resulting combination of the Core and Satellite portfolios offers the following advantages:

• Increased stability of returns:

The portfolio should deliver more stable returns more closely matching those of the benchmark, with the
added possibility of some outperformance if the active managers perform well.

• Reduced Management Cost:

The Core portfolio, with its lower management costs by design, will bring down the overall costs of the
portfolio. As the Core portfolio is often based on indexes that do no change often, there should be lower
transaction and rebalancing costs.

Overall, the Core and Satellite approach offers a flexible, cost-effective way to manage an investment portfolio.

Source: www.hottingerzurich.com

All the best,

Cor van Deventer
info@seedinvestments.co.za
www.seedinvestments.co.za
021 9144 966