Pension funds have long been using a strategy known as “core/satellite” investing. This involves using an index fund for the core of a portfolio and utilizing active funds for the satellite positions. The overall strategy aims to reduce the costs of investment management since many large, actively managed mutual funds do not look very different from their benchmark indices, yet charge a high fee. It is so common, that the phrase “closet index fund” was coined many years ago. This refers to an actively managed fund that looks only slightly different than its benchmark index.
By using a less expensive index fund for the core of a portfolio (between 20% to 80%), an investor reduces their investment management costs and captures most of the risk and return characteristics of most well-diversified portfolios. Using active managers who are truly different than the benchmark index can complement the indexed core very well.
Most broad index funds have a large-cap bias so many satellite managers chosen as satellite managers may have small- or mid-cap biases. The end result is a portfolio with lower costs for the investor without sacrificing choice.
Benefits of incorporating an indexed core:
- Maximum Diversification
- No Overlap
- No Style Drift
- No Manager Changes
- Low Turnover
- Lower Expenses
- Lower Taxes
- Greater Simplicity (Back to basics)
- Proven to outperform the majority of active managers
Always consult with a qualified financial professional for assistance in determing a recommended split between active and passive strategies.
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