Professional stock pickers are having a difficult time (again) beating the market. Lipper estimates that 85% of large-cap fund managers unperformed their benchmark last year. That’s the worst showing in three decades!
This kind of pathetic performance, especially during a favorable period of performance for stocks, is getting more advisors to rethink how they construct client investment portfolios. In particular, it’s pushing advisors toward a strategy of core/satellite with the core being indexed via low-cost ETFs.
The core portfolio always consists of broadly diversified funds that touch major asset classes like equities in developed and emerging markets, bonds, commodities and real estate. Think about the core as a portfolio’s foundation. And that foundation, just like one supporting a building, should be solid enough to withstand the fiercest of storms.
Putting non-core asset classes like individual stocks, actively managed funds, private equity, venture capital, managed futures, derivatives and collectibles inside a core portfolio is like putting ice cream into the oven. It doesn’t belong there! These types of non-core assets are complementary to a person’s core portfolio and are best kept inside a satellite or non-core portfolio.
Here’s another way to think about the relationship between a core portfolio and satellite portfolio: The satellite is the appetizer, the core is the main course. For that reason, the bulk of a person’s assets and net worth will always been contained in their core portfolio.
In extreme cases, when a high-net-worth individual has a substantial portion of assets tied up in a single stock or company or other asset, it’s the advisor’s duty to help that person cut risk and exposure to that single asset by re-diversifying money into a broadly diversified core portfolio. It’s your job to identify the risk and attack it.
The core/satellite portfolio strategy helps advisors have a logical and consistent portfolio-building approach. There is no other way. Why? Because an infinite number of investment strategies invariably lead to an infinite number of bad choices. That leaves the discerning advisor with no choice but to construct portfolios using a robust framework. And that’s what the core portfolio strategy is all about.