What in the Multiverse? The Investible Universe and Core-Satellite Portfolio Strategy
When you start investing, it's essential to understand the concept of the investible universe. This term refers to all the possible investments available to you, like stocks, bonds, real estate, and other assets. Think of it as a giant menu of choices for where to put your money. For simplicity, let's focus on shares. Your investible universe for shares includes options from Australia, the United States, Europe, Asia, and so on.
The Importance of International Diversification
While investing domestically in Australia might seem convenient, limiting your investments to one country can be risky. Different countries have different economic conditions, and by investing internationally, you spread your risk across various markets. It's like not putting all your eggs in one basket; if one country's market struggles, your investments in other countries might still perform well. This strategy is called diversification and think about this as part of your investible universe.
Screening or Filters
Once you outline your investible universe, you can apply screens or filters to narrow down your choices. A screen or filter is exactly what it sounds like – a way to select investments based on certain criteria. For example, you might choose only companies of a certain size or exclude industries like coal mining or gambling.
Core and Satellite Portfolio Strategy
Imagine your investment portfolio as a sailing boat. The core portfolio is the sturdy hull of the boat, providing stability and steady progress. The satellite portfolio is like the sails, catching the wind and potentially boosting your speed.
Core Portfolio
The core portfolio should make up about 70% to 80% of your total investments. It consists of broad-based, low-cost index funds such as ETFs that track the market. These funds are typically passively managed, meaning they follow a market index rather than trying to beat it. The goal here is to achieve reliable, market-level returns with minimal effort and cost.
Satellite Portfolio
The satellite portfolio accounts for the remaining 20% to 30%. This part is more flexible and can be actively managed, aiming to outperform the market. It can include specialised ETFs (Exchange Traded Funds) or investments where you have strong convictions. For example, if you believe in the future of renewable energy, you might allocate some of your satellite portfolio to that sector.
Key Points for a Successful Core and Satellite Strategy
Percentage Allocation: While there's no magic number, a common split is 70-80% in the core portfolio and 20-30% in the satellite portfolio.
Management Style:
Core Portfolio: Passively managed with broad-based, low-cost index funds. This part is like the solid hull of your boat, ensuring stable progress.
Satellite Portfolio: This can be actively managed and may include specialised ETFs or investments in areas where you have a high conviction. This part acts like the sails, potentially boosting returns. Some examples are known as thematic ETFs, which are built and owned companies within a specific industry or thematic such as cryptocurrency, renewables, geographies or markets such as Asia.
Stay Within Your Circle of Competence: It's important to invest in what you understand. Rather than chasing the latest hot tip from a friend or an online forum, focus on areas where you have knowledge or consider using a specialised ETF or a professional fund manager.
Avoid over-diversification in Satellite Portfolio: Adding too many stocks can lead to high management fees and complexity. It's better to have a focused satellite strategy than to spread yourself too thin.
Passive vs. Active Management
Passive Management: Involves investing in funds that track an index. It's low-cost and low-effort, aiming to match market returns.
Active Management: Involves picking individual stocks or funds to try and beat the market. It requires more effort and usually comes with higher fees.
Example Portfolio: The 110% Portfolio Concept
Here’s a practical example of how these concepts come together:
40% VAS ETF: An index fund investing in the top 300 companies on the Australian Stock Exchange (ASX).
40% VGS ETF: An index fund investing in about 1,500 companies from developed countries, excluding Australia.
10% GOLD ETF: This represents an investment in gold.
10% HBRD ETF: A specialised, actively managed fund.
10% Cash: For liquidity and potential opportunities.
In this example, VAS ETF and VGS ETF represent the core (approximately 80%), providing broad, low-cost exposure to Australian and international markets, however, they screen out smaller companies in Australia and predominately focus on the largest companies in the United States. GOLD and HBRD represent the satellite (20%), offering the potential for higher returns with specialised investments. Remember, the core portfolio ensures stability, while the satellite portfolio aims for higher growth.
