Core & Satellite
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Core & Satellite is an investment strategy that uses the traditional Fixed Income & Equity based securities with a division of the equity side into a "Core" and a "Satellite" allocation.
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[edit] Core
The "Core" is made of passively managed securities (index funds, ETFs, passive mutual funds) and uses a traditional benchmark (examples are the Russell 3000 or the S&P 500 Index) to compare for performance. The positions may have a particular style bias (examples: more small cap stocks over mid/large cap companies, more value positions over growth positions, higher or lower concentration in developed international markets) but is relatively consistent in blend by allocation. Because of the holdings passive nature and the belief that this structure is essential to long term planning; these holdings are generally not swapped for another type in this class style and are rarely sold unless the client either needs cash for personal use, the allocation is out of bounds within the constraints of the portfolio's plan, or the clients mix of fixed income/equities ratio is modified based on premeditated or unforeseen client events. This style allows to greater tax sensitivity inside the investments, returning fewer short and long term capital gains exposures, and on the individuals/companies tax return.
Some advisors also use separate account managers over passive managed holdings under this style if the manager's bias is towards tax-management to limit transactions and capital gains. The advantages can be greater tax efficiency with lot based trades, trading a position based on when it was purchased as opposed to the standard of First In First Out (FIFO) accounting method, and the potential for greater returns on account positioning that weighs holdings differently then an ETF or passively managed fund.
[edit] Satellite
The "Satellite", in contrast, are made of holdings that the advisor feels will gain alpha, the financial term for estimating returns in excess of risk, to increase returns for the portfolio. Holdings may include actively managed stocks, mutual funds, and separate account managers with a particular sector, region of positions, or Micro or Mega Cap Company Holdings, or passively managed assets with a particular style that is counter to, or even enhances, the style bias of the core may also be included. Short holding periods & tax inefficiency of the positions may result in short term capital gains (or losses) causing higher taxable gains (or losses) in a calendar year.
If the entire allotment of the "Satellite" is not deemed worthy of inclusion, that portion will either be reallocated across "Core" positions or in a "Satellite Holder", a position that mirrors some aspect of the core (generally the position most closely resembling the benchmark) that is quickly traded when an opportunity is identified by the manager and doesn't cause major tax issues with FIFO based trades.
This style maybe implemented into 100% equity allocations and allocations that blend with fixed income or non-equity positions, but is generally not used for those lacking sufficient investible assets or for large institutional clients lacking tax implications. Even though Satellites are classified under equities, many alternative assets, hedge funds, REITs, commodities, options, foreign currencies, and even emerging market debt and junk bonds may be included as a Satellite Portfolio Position.
Portfolios are more that a bunch of financial assets, and Satellite investments must be selected and managed considering the portfolio as a whole. The Satellite should improve not only the return, but the risk/return profile of the portfolio, and not only quantitatively (the Sharpe ratio or whatever other risk/return measures used) but also qualitatively, by adding sources of value (non-correlated strategies, short and medium-term investment ideas, risk-asymmetric assets...) different from that in the Core but still consistent with the analysts market view and the investor goals.
[edit] Theory of this Investment Style
Historically, greater active management of a portfolio generally results in greater returns and taxable interests. In lower return environments, active management of core positions generally underperform passive management after taxes & expenses in real return performance. By limiting the taxes and the expenses inside the core holding, the potential return lost from passive management is significantly offset by the strong correlation in return to large equity indexes. Additional returns come from assets with projected future returns in excess of the core benchmarks after taxes, inflation, & expenses.
