Which global fund will you choose this ISA season?
2023 has, so far, started more positively than 2022, especially when it comes to stock and bond...
Think back to your school science projects. No, not the baking soda–molten lava volcano experiment, the one on outer space. Chances are someone in your class built a model of the earth surrounded by satellites. Now apply this visual to your investment portfolio.
You may have heard about the core-satellite investing strategy without really knowing what it means. The broad brush strokes are possibly clear enough—some sort of large central investment along with a whole bunch of smaller, less vital investments—but what should these investments be?
Are there set rules or specific assets? Is there only one way to build a core-satellite portfolio? Why use this strategy? FundCalibre takes a look at one approach.
Core-satellite portfolios aim to spread your investing risk in a way that gives you a good chance of making returns over and above the market average or a particular benchmark, but still reduces the volatility to which your money is subjected.
Another advantage to core-satellite is that you set up your portfolio to perform well over the long term and through different market cycles. Having this diversified structure in place can help you to resist ‘meddling’ when markets are volatile, meaning you reduce your chances of selling at the wrong time and losing money.
Learn more: 7 tips to help you build the perfect portfolio
Outside of the gym, core is not such a dirty word. There are lots of different theories on how to construct a core-satellite portfolio, but we refer to your ‘core’ holdings as those asset classes and particular investments that are considered fundamental to generating long-term positive returns.
Investing style also plays a part in determining what might be a core holding and what might be a satellite. For example, some sort of core UK All Companies fund should be suggested if you are building a balanced portfolio. But within the UK All Companies sector, funds come in all shapes and sizes.
A ‘core’ holding might be a fund like the Elite Rated Investec UK Alpha, whose manager has a respectable growth target, a proven track record and a straightforward mandate to find quality companies that consistently create value for shareholders, typically at the larger end of the stock market. He doesn’t take on especially high levels of risk for an equities fund and, as such, our FundCalibre risk rating for the Investec UK Alpha is currently a 6 out of 10.
So you may choose to invest a larger percentage of your money into this than some of your other investments. Over the long term, it has made a good habit of outperforming the UK stock market and boosting investors’ total returns.
The UK stock market does go through rough patches! And for all sorts of reasons, sometimes certain parts of the market perform better than others. For example, in the year-to-date, returns from the UK’s larger companies have beaten its smaller and medium-sized businesses (small- and mid-caps) by a long shot, albeit they are mostly all in negative territory on Brexit concerns.
2015, however, was a different story. The index most commonly used to measure mid-cap stocks, the FTSE 250, returned 11.2% in 2015. The FTSE UK Small Cap rose by 11.3%. The FTSE 100, which tracks only the 100 largest listed companies, lost 1.3%1.
So how can you make sure you get the best of both worlds? With some satellite investments!
Looking at the above figures, you may decide you want some exposure to small- and mid-cap stocks as well. Elite Rated funds including the Liontrust UK Smaller Companies and the Marlborough UK Micro-cap Growth both focus on small caps. Dedicating a percentage of your portfolio to a fund such as these in addition to your core holding would give you the chance to smooth over your total portfolio returns – if one part of the market is not performing, you may still have the chance to do well in another.
Another way to diversify within the UK All Companies sector would be to hold a UK equity fund that operates a totally different investing strategy. One such fund is the Elite Rated Schroder Recovery. FundCalibre considers this a higher risk investment than many of the other UK All Company funds; it comes in with a risk rating of 7.5 out of 10, which is one reason it may be more suitable as a satellite than a core investment.
The higher risk rating relates to the fact that Schroder Recovery is a value fund, which invests in companies whose share prices have fallen significantly below what is considered ‘fair value’ and which the managers believe are due for a turnaround. If this transpires, investors can make impressive returns and over the long-term the track record is good. However, it’s almost inevitable there will be periods when this fund is underperforming the market or when your returns are in negative territory.
Of course, the world’s a big place and you don’t just want to be concentrated in the UK, diversified though your domestic holdings may be. After you’ve built up a few more core holdings, including potentially a US equity fund, a European equity fund, a UK equity income fund and maybe a UK fixed income (i.e. bond) fund too, you can start to explore more satellites.
These could be an emerging markets equity or bond fund, a Japan fund, an India fund, an Asian income fund, the list goes on. And just like with the UK example, you could chose a core US holding such as the Elite Rated Brown Advisory US Flexible Equity, and then a sector specialist fund to supplement it, such as the Elite Rated AXA Framlington Global Technology.
FundCalibre has Elite Rated funds in all these categories to help you do your own research and choose investments to suit your needs.
1FE Analytics, FTSE 100 vs FTSE 250 vs FTSE UK Small Cap, TR in GBP; 31/12/2014–31/12/2015 vs 01/01/2016–14/06/2016, accessed 15/06/2016