Executive Summary
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Core–satellite investing involves the separation of portfolios into a passively managed “core” (conforming to a strategic asset allocation framework) surrounded by actively managed “satellites” made up of active long-only funds and alternative investments.
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While this structure yields operational benefits, it stops short of its full potential as a portfolio construction rubric since it deals only with superficial labels (asset classes). Instead, institutional investors are beginning to think in terms of alpha (skill-based) returns and beta (index-based) returns.
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The separation of alpha and beta, regardless of their source, is a more accurate way to view core–satellite investing.
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This bifurcation has recently led to major changes in the way some pension portfolios are managed and in the way that asset managers service their clients. Asset classes once treated as separate or distinct are now converging into one integrated alpha/beta paradigm.
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Though challenges remain, there is little doubt that core–satellite investing has unleashed a wave of change that is reshaping asset management.
Introduction
“It is the pervading law of all things organic and inorganic…that form ever follows function.”
Nineteenth century Chicago architect Louis Sullivan famously observed that a building’s design must follow from its functional use. The same might be said about the design of modern portfolios and their management entities (pensions, endowments, asset managers, etc.). After emerging over the past decade as a simple portfolio management rubric, core–satellite investing is leading to a wholesale reengineering of the investment management function.
Core–satellite investing can generally be described as the separation of beta-centric (core) investing from alpha-centric (satellite) investing. However, the term has become stretched and overused. Today, “core” often refers to any number of passive asset classes and even to actively managed mandates. But a more literal definition of core as pure beta and satellite as pure alpha helps to shed light on one of the most significant underlying trends in asset management today—convergence.
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