RJCAPITAL

RJ Capital’s Core / Satellite Strategy is our implementation of active and index investment strategies together to achieve the asset allocation policy. The core-satellite approach is really just another way of thinking about allocating money among asset classes. A core-satellite approach is an investment strategy that combines passive and active investment management styles. The idea is that the appropriate combination can achieve a synthetic enhanced indexing, which aims to consistently outperform a chosen benchmark. The principle behind the core-satellite approach is that most of the portfolio will be dedicated to matching its benchmark with low risk, while a smaller allocation will target enhanced returns so that, when the two elements are combined, the portfolio is potentially able to beat its benchmark in a risk-controlled manner.

Under this approach, the bulk of the portfolio (the 'core') is invested in passively managed funds, while the rest is invested in actively managed, high-alpha funds, which make up the satellite element. The passively managed funds should be able to produce returns that are close to benchmark with very low tracking errors and at low cost. The satellites, in contrast, will aim for higher returns, for instance 3% over benchmark.

Many investors find it attractive because it allows them to take advantage of the long-term benefits of core investing while also gaining modest exposure to sectors with the potential for more dramatic returns. The key to success in implementing a core-satellite structure in your portfolio depends on two main factors: your risk tolerance and the satellite investments’ ability to generate market-beating returns. Properly implemented, a core-satellite strategy may result in a better designed portfolio with lower risk, and most likely better long-term performance.

Satellite holdings generally represent only a small percentage of an investor’s portfolio, but are there for a specific purpose. Most commonly, a satellite position complements core holdings, seeking extra return from a more aggressive investment. For mutual fund investors, this is usually a fund that specializes in a narrow market sector or investment style. For example, funds that invest exclusively in international small company stocks, real estate securities, or high-yield bonds might be good satellites for core holdings in large company American stocks or U.S. government bonds. Concentrated portfolios – those that place big bets on a relatively small number of holdings – may also be good choices for satellites.

Regardless of the specific investments chosen to fulfill the asset allocation, remember that costs, taxes, risk (portfolio volatility) and return (investment returns) are the underlying considerations of our Total Portfolio Management. A brief review of each area provides additional insight.

Costs & Taxes
The core portion of the portfolio helps to minimize costs because passive investments are almost always less expensive than their active counterparts. Because passive investments track indexes, the portfolio changes only when the index changes. Because indexes change infrequently, this minimizes transaction costs and capital gains taxes. Active portfolion management, on the other hand, is based on trading. Each trade generates execution costs and potential tax liabilities in the form of capital gains.

Volatility (Risk)
Beta is a measure of stock market volatility. Volatility is something many investors prefer to avoid. By dedicating a large portion of a portfolio to passive investments, the beta of the total portfolio should come in somewhere close to average. Adding investments, such as a commodities fund, which are not correlated to the movements of the stock market as a whole, helps limit overall volatility when the markets are in flux.

Returns
Active managers seek to outperform their benchmarks. By allocating the majority of a portfolio to passive management, the portfolio's risk level remains similar to the risk level of the benchmark. By allocating a minority of the portfolio to active management, the opportunity is in place for an active manager to outperform the benchmark, thus adding to the return generated by the overall portfolio and resulting in benchmark-beating returns for the portfolio as a whole.

Implementation Strategies
A core/satellite portfolio can be implemented in a myriad of ways. The strategy can be implemented using various combinations of separately managed accounts, exchange-traded funds (ETFs), mutual funds, stocks, bonds and any other combination of core index-tracking investments coupled with alpha-seeking investments.