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How to follow a core and satellite approach for the debt-fund portfolio?

While the core is the mainstay of one's portfolio, satellites are tactical allocations which may be slightly higher on risk with better long-term return potentials, says Ashutosh Gupta

How to follow a core and satellite approach for the debt-fund portfolio?
- Muthukumar S

As the name suggests, under a core and a satellite approach, you essentially build your portfolio with two components - core and satellite. Here, the core is typically the mainstay of one's portfolio. For the core investments, you typically would not want to take much more risk than the overall risk inherent in that asset class, remain well-diversified, keep your risks under control, and expect to beat the market for a little bit, or simply match the market in terms of returns for those opting for a passive strategy for the core.

Now satellites are basically smaller, supplementary or tactical allocations which may be slightly higher on risk but have a better return potential over the long term. Owing to the higher risk, investors won't want to go overboard with these kinds of allocations, but you want to add them in a measured dose to boost your overall returns. So, this is the overall concept of building an overall core and satellite portfolio. It is possible to implement something similar with your debt allocation as well.

On the debt side, for your core portfolio, you would want investments that are well diversified, which do not take too much of credit risk by investing heavily in lower-rated bonds, keep the interest rate fairly under check by not going overboard on bonds of a very long maturity and generally maintain a portfolio which scores well on liquidity. So, these are the kinds of tenets that you would want to achieve from your core debt allocation. This is where we believe short-duration funds fit the bill for your core fixed-income portfolio.

Now for the satellite allocation, these could be in funds which take slightly higher credit risk by investing in bonds of lower-credit quality or take duration calls by investing in longer maturity bonds, as both these strategies help you derive extra yields. So, for credit, there are credit-risk funds which one may want to add in a small supplementary allocation or on the duration side, one can look at funds like gilt funds, dynamic bond funds or other medium- to long-duration categories.

But I'd say that for a majority of investors, they have very low-risk tolerance in their fixed-income portfolio and they don't like a lot of volatility. So, for a vast majority of investors, it may just be suitable to stick to the core allocations and give a skip to the supplementary allocation altogether. With their core allocations, they can aim to achieve the returns which are slightly better than what a bank FD could fetch and that should be good enough.

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