Warning on risky satellite strategies

A warning has been issued about the use of the core/satellite investment strategy, with some advisers using satellite investments as the ‘gambling’ portion of a portfolio.

The core/satellite approach to portfolio construction, with index funds at the core and active funds as the satellites, has become increasingly popular among advisers over the past 12 months.

Vanguard head of retail Robin Bowerman said this was the result of adviser dissatisfaction with active managers during the market collapse, as well as increasing pressures to reduce the cost of portfolio construction for clients.

Index manager Vanguard is one promoter of the strategy. It recommends that advisers construct portfolios with a core of cost-effective index funds to capture market returns, while choosing actively managed ‘satellite’ funds where the adviser has conviction that a particular asset class or manager may outperform.

But Morningstar co-head of fund research Tim Murphy has warned some advisers may be taking their conviction too far.

Murphy said while the core/satellite isn’t necessarily a bad approach, the aggressive manner in which some advisers are implementing the satellite part of the strategy is a cause for concern.

Murphy said there was evidence of advisers placing the core of the portfolio in Australian equity investments, while placing the satellite investments in high-alpha, high-cost and high-risk funds — essentially using the satellite funds as the ‘gambling’ portion of the portfolio.

The core/satellite approach is “problematic if implemented in the wrong way”, Murphy said. He reinforced the need for advisers to be cautious about fund selection — even in the satellite portion of clients’ portfolios.