You must have often read about the virtues of building a core and satellite portfolio in these pages. Mint50, which is Mint’s curated list of 50 mutual funds chosen after an exhaustive research exercise, advocates portfolio construction using the core and satellite approach. So what is core and what is satellite? Remember, these are not categories that have been defined by the regulator, but approaches to portfolio building that most financial planners follow.
Assume you don’t have any investments in mutual funds and are starting afresh. Ideally, you should have a portfolio of 6-8 schemes, ranging across different categories of mutual funds. When you start buying mutual fund schemes afresh, your first two or so schemes should ideally be low-risk. The reasons are that since you are just stepping into the world of mutual funds, you need to select funds that come with a good, long-term track record and are consistent performers. Also, these are simple, plain-vanilla schemes that are expected to do well across market cycles. Sure, when equity markets fall, most of your equity funds would fall as well, especially if the markets are falling continuously. But the plain-vanilla schemes should ideally fall lesser than the rest of the market and their peers. These steady performers can become your portfolio’s foundation in the long run. These are the core schemes.
Once you have got your foundation in place, you can now afford to take slightly more risk. Here’s where your satellite schemes come in. Typically, these are schemes that aim to give returns kicker to your portfolio, such as thematic funds or those that follow differentiated strategies or those that work well in some and not all markets. These fall under the category of satellite schemes.
Satellite schemes add a flavour to your portfolio and you may not hold them for long periods of time. For instance, closed-end funds launched when fund managers expect equity markets to rise, are also satellite funds. Since closed-end funds come with a specific tenure, they get redeemed at the end and you get your money back. Bear in mind that typically, satellite schemes are more risky than core funds.
You can even restructure your existing portfolio according to a more appropriate core-satellite mix. If you have too many schemes that are the ‘flavour-of-the-month’ or thematic in nature, it means that your satellite portion is too high. You need to trim that down.
Must you really invest in satellite schemes? If these are riskier than core schemes, can an investor choose to avoid them altogether? We think it’s necessary. In fact, for a successful portfolio, you need both types of funds.
You obviously need the core schemes because they are the solid, long-term performers. But markets provide enough opportunities to make money in certain segments at all points in time. Closed-end schemes launched in 2013 leading to the central government elections in May 2014 provided one such opportunity. Infrastructure funds in 2005 and 2006 were an earlier opportunity to make money from, if you had invested, and also withdrawn from them, at the right time.
Remember to not abuse the satellite portion of your portfolio. Don’t get greedy and keep buying satellite funds beyond your risk appetite. For instance, if you would have kept buying infrastructure funds in 2007, you would have lost money when equity markets crashed in 2008 on the back of the global credit crisis. Closed-end funds, too, have continued to hit the market, even after the central government elections were done and dusted, but not all such funds have made money. Satellite schemes are seasonal; they will come and go from your portfolio.
If you can make sure you get your core-satellite mix right—or consult a financial adviser if you don’t know how to do this on your own—your portfolio is set.