Three ways to build a core and satellite portfolio today

There are a lot of considerations that go into building an investment portfolio but ultimately, long term, it boils down to finding a balance between growth and risk. Achieving your financial goals requires a thoughtful approach to portfolio construction — especially considering your personal risk levels.

One strategy that investors can adopt is known as “core and satellite” investing. This technique aims to spread investment risk, while enhancing returns, by combining stable core holdings with more exciting satellite investments.

In this guide, we will explore the core principles of core and satellite investing, offering insights on how to choose both core and satellite holdings. And offer a few suggestions for those looking to enforce this style today.

 What is Core and Satellite investing?

Firstly, core and satellite investing is a portfolio construction technique designed to strike this balance between growth and risk. The core represents the stable foundation of the portfolio, think of these as your stable building blocks. They are reliable and consistent performers, regardless of market conditions. These are typically funds with respectable growth targets, proven track records, and a mandate to invest in quality companies that consistently create value.

On the other hand, satellite investments are added to the core to strengthen returns. These investments make up a smaller proportion of the portfolio, providing investors with the opportunity to explore more exciting or risky opportunities without exposing the entire portfolio to excessive risk.

Want to learn more about this approach? Our core and satellite guide breaks down all the key concepts, advantages and disadvantages.

How to choose a core holding

Selecting a core holding is a crucial step in the core and satellite investing approach. Core holdings form the backbone of the portfolio and should be chosen based on stability, reliability, and a proven ability to deliver returns. Consider the following factors when choosing a core holding:

1. Growth target and track record

Look for funds with a decent growth target and a manager who has demonstrated the ability to deliver consistent returns. While it’s a well-known fact that past performance doesn’t dictate future performance, a fund’s historical performance and track record provide valuable insights into its stability and reliability. It’s also important to be mindful of the manager’s start date when conducting your research. There’s a difference between a strong 10-year performance and a manager who only took over management a year ago.

2. Investment approach

Understand the fund’s investment approach. Core holdings often invest in stable, dividend-paying large companies with well-established business models. Consider whether the fund aligns with your investment objectives and risk tolerance. This is a good time to consider if you want to incorporate ESG elements in your portfolio or avoid particular regions or sectors.

3. Global reach

Diversification is key to a robust core holding. Funds with a global reach and the freedom to invest in companies across different regions can offer stability by avoiding over-reliance on a specific market or sector. While you’ll often see global equities make up a large number of “core” recommendations, core funds can be found across all regions including the UK and Europe – although we wouldn’t suggest a European Smaller Companies fund, for example, as a core holding.

How to pick satellite holdings

On the flip side, choosing satellite holdings allows investors to add a dynamic element to their portfolios, exploring more exciting areas or niche opportunities of the market. Think of these holdings as a little bit of spice to your meal. Here are three considerations for selecting satellite holdings:

1. Diversification

Satellite holdings should complement the core by adding diversity to the portfolio. Consider areas that are less correlated with traditional markets to enhance overall diversification. For example, you may decide you want exposure to small- and mid-cap stocks as well. Alternatively, you could opt for a different investment strategy by backing a value or contrarian fund.

2. High-potential areas

Explore potentially exciting areas, such as emerging markets or industries with high growth potential. Satellite holdings provide the opportunity to capitalise on areas that may deliver better-than-expected returns. These opportunities could range from the niche biotech and healthcare sectors to more popular technology sectors.

3. Risk tolerance

Recognise that returns from satellite holdings may be more unpredictable, and there could be increased volatility in this portion of your portfolio. It’s important to assess your risk tolerance and allocate an appropriate percentage of your portfolio to satellite investments. If you want to reduce your risk level, consider looking at fixed income funds to complement your core holdings.

Not sure of your risk tolerance? Watch our 4-minute guide on how to determine your risk profile.

Three ideas for building a core and satellite portfolio today

1. Balanced

A balanced portfolio is comprised of roughly 50% equities and 50% fixed income with the aim of reducing volatility. Of course, this type of asset allocation can still follow the core and satellite approach to fund selection with both core and satellite positions in both.

Capital Group New Perspective invests in some of the world’s largest names, such as Microsoft and AstraZeneca*. The fund’s unique multiple manager structure avoids any key person risk making it an interesting fund for investors looking for a core large-cap global growth position. Another core position might include the M&G Corporate Bond fund, run by the highly experienced Richard Woolnough for over twenty years, this fund invests primarily in sterling-denominated investment grade debt.

One satellite position within fixed income could include the newly-rated BlueBay Emerging Market Unconstrained Bond fund. This is a unique high conviction fund run by an exceptionally experienced and well-resourced team. IFSL Marlborough Global Innovation, is a concentrated portfolio of fast-growing, innovative companies, with a minimum 50% of the fund invested in smaller companies. This exposure to small-cap technology names has the potential for high returns and an interesting satellite position for those looking for small-cap exposure.

2. Income

Those investors looking to generate income will focus primarily on investing in dividend-paying stocks, or equity income, and fixed income. This type of portfolio might suit an investor looking to produce a regular yield to supplement an income during retirement.

A core position in an income portfolio, for example, might include JPM Global Equity Income or WS Evenlode Global Income. Both are solid core global equity income funds with a focus on dividend growth which should give investors a growing income stream. Baillie Gifford Strategic Bond is one example of a core fixed income holding. Managed by Torcail Stewart and Lesley Dunn, this fund has a straightforward, bottom-up selection process.

Satellite positions might include Asian equity income funds such as Schroder Asian Income or Jupiter Asian Income. Another option in fixed income might be M&G Emerging Markets Bond which has the flexibility to invest across the whole emerging market bond spectrum and a current yield of 6.6%**.

3. Sustainability

Investors looking to construct a sustainable or responsible portfolio can still follow the core and satellite approach. It’s important to consider the investment process and asset allocation between equities and fixed income but here are a few core and satellite options for the ESG focused.

CT Responsible Global Equity is an active core global equities fund with a robust sustainable approach, investing in quality growth companies with a focus on sustainability. Another example of a core global equities fund would be Liontrust Sustainable Future Global Growth. The fund uses a thematic approach to identify the key structural growth trends that will shape the global economy of the future across a portfolio of 40-60 stocks.

Those looking for a core income holding may want to consider the Janus Henderson UK Responsible Income fund. Manager Andrew Jones has extensive experience in the equity income space and has a common-sense approach to this fund, he won’t chase yield and will look for a balance of growth as well as an attractive income.

Investors are spoiled for choice when it comes to satellite options within the sustainability sector. The Redwheel Biodiversity fund is one such option. This fund seeks to profit from what it believes is a multi-decade growth opportunity arising from the drive to protect biodiversity. The fund has only recently launched so it will have to prove it can deliver results – but this fund is certainly one to watch.

The WS Montanaro Better World fund could be an option for those looking to add a little small-cap spice to their portfolio. This fund looks for companies whose products or services are making a positive impact on the world, focusing on small- and mid-cap stocks.  And those looking for income ideas in their portfolio could consider a position in an alternative income stream, such as VT Gravis Clean Energy Income which looks to generate income from renewal energy and energy-efficiency related projects, with an expected yield of 4.5%**.

Curious about other investment strategies? Learn more about the 60/40 strategy here.

Conclusion

Core and satellite investing offers a strategic approach to building an investment portfolio that balances stability and growth. The core provides a reliable foundation, while satellites add excitement and the potential for enhanced returns. As with any investment strategy, there are no guarantees, and investors should carefully assess their risk tolerance and investment objectives.

Investors interested in a comfortable blend of stability and excitement may find the core and satellite approach appealing. Regularly reassessing and rebalancing the portfolio ensures that it continues to align with your preferred asset allocation and risk-reward balance.

Remember, the key to successful investing is a thoughtful and diversified approach that aligns with your financial goals and risk tolerance. Whether you’re selecting core holdings for stability or exploring satellite opportunities for growth, the core and satellite approach can be a valuable strategy in your investment journey.

*Source: fund factsheet, 31 December 2023

**Source: fund factsheet, 30 November 2023