Core-Satellite Approach
Preet’s general portfolio management philosophy uses a “core-satellite” approach, sometimes also referred to as “core-and-explore”. Low-cost indexing products (such as Index Exchange Traded Funds or Index Mutual Funds) represent the core of a portfolio, with active management through funds or individual security selection representing the ’satellite’ portion of the portfolio. The main premise is that neither the average investor nor the average professional money manager can outperform the markets over long periods of time as documented by Burton Malkiel in the book, A Random Walk Down Wall Street, and espoused similarly by John C. Bogle, the founder of The Vanguard Group.
The factors for this average underperformance can be attributed to:
1) General underperformance of actively managed mutual funds versus their benchmark indices
2) High relative fees of actively managed products
3) Investor behaviour and lack of investment decision protocols
Support for the effect of the lack of investor discipline and investment protocol is provided by the Quantitative Analysis of Investor Behaviour report released by DALBAR. It noted that from the period of January 1984 to December 2002 the S&P500 index averaged a return of 12.22% while the average American mutual fund investor averaged a return of only 2.57%, this represents a general underperformance of 9.65%. (It should also be noted that other reports have estimated the underperformance to be closer to 5%). Nonetheless, all reports attribute these findings in large part due to the performance-chasing nature of the average investor who is prone to picking investments based primarily on recent performance as opposed to implementing a clear set of investment protocols (i.e. through an Investment Policy Statement).
Core
The Core of the portfolio is constructed using lower cost, indexation products since performance of the underlying benchmark indices has been shown to outperform the vast majority of actively managed portfolios. The Core allocation of the portfolio can represent between 60% and 100% of the overall portfolio. For most investors, it is recommended that the portfolio be 100% Core allocated. Where the client has expressed an interest in active management, the core allocation can be reduced as necessary to facilitate a larger Satellite allocation.
Satellite
The Satellite portion of the portfolio is designed to use active management principles for investors who are willing to take on additional risk in exchange for potentially higher rewards. The active management can take the form of using specialized money managers (i.e. managers who specialize in less efficient markets such as natural resources, small cap stocks, emerging economies, etc.), purchasing individual stock or bond positions that seem extraordinarily attractive, or initiating trading positions in various securities. It is not necessary to have a Satellite allocation in the portfolio, and further it is not recommended for novice investors. The criteria for investments that can be included in the Satellite allocation of your portfolio are detailed later in this IPS.
