Core and satellite

Passive investing is cheap and predictable but will never beat the market. Active investing might, but it is expensive and uncertain. Core and satellite does not force the choice.

• The core is the large, stable part — usually passively managed, reflecting the portfolio's long-run risk profile and keeping costs down.
• The satellites are smaller, actively managed pieces that try to capitalise on short-term opportunities and add return.

In the workbook's words: the core minimises costs, the satellites enhance return. A portfolio generally holds about 70% to 80% in the core and the balance in satellites.

The workbook's comparison of the two parts:

The workbook gives two reasons for its popularity: it is a very intuitive way of investing, and it combines the best of active and passive management. It also lists core-and-satellite, along with alpha-beta separation, as a force behind the growth of passive and index funds.

Portfolio cost   = w_core × cost_core + w_satellite × cost_satellite
Portfolio return = w_core × return_core + w_satellite × return_satellite

Illustrative figures. A ₹1 crore client of a portfolio manager wants market-like returns with some chance of beating the market, without paying active fees on everything.

Blended cost = 0.75 × 0.20% + 0.25 × 2.50% = 0.15% + 0.625% = 0.775%

That is about ₹77,500 a year, against ₹2.5 lakh if the whole ₹1 crore were in active strategies at 2.5%.

The core is judged by how closely it tracks the Nifty 50 — its tracking error. The satellites are judged by risk-adjusted return. If a satellite strategy disappoints, the manager replaces it without disturbing the ₹75 lakh core or triggering capital gains tax on it.

Chapter 18 (Equity Portfolio Management Strategies), section 18.10, presents the approach with the 70%–80% core share and the core-versus-satellite table above; section 18.14.5 links it to the rise of index funds. Questions test the characteristics table — which part is passive, which is judged on tracking error, which part generates short-term capital gains.

• Core ≈ 70% to 80%, satellites the balance — not the other way round.
• Core = passive preferred, judged on tracking error. Satellite = active preferred, judged on risk-adjusted return. Swapping the performance measures is the typical trap.
• The core reflects the portfolio's long-run risk profile (strategic allocation); satellites are tactical.
• Core holdings earn long-term capital gains; satellites' frequent trading generates short-term gains — the workbook includes this in its comparison.
• A Chapter 18 sample question lists core-and-satellite and alpha-beta separation as drivers of passive fund growth — both are, because each routes the bulk of the money into index exposure.