COLUMN-Picking satellites to revolve around your core

Fri Nov 16, 2012 9:38am EST

By John Wasik

CHICAGO Nov 16 (Reuters) - The "core and satellite" strategy for portfolio management is an elegant and simple approach that will not only help you diversify but allow you to reduce your country and political risk.

Your core consists of broad indexes of stocks and bonds with exchange-traded funds like the Vanguard Total World Stock Index ETF and the Schwab U.S. Aggregate Bond ETF.

Then you can have some fun by working on satellite holdings that include emerging markets, specialized themes and dividend payers. These are more specialized investments that focus on long-term global growth and help distance you from increasing volatility and the slow-growth economies of the U.S. and Europe.

Although you can set your allocation any way you'd like to accommodate your long-term goals and risk tolerance, a boilerplate mix would be about 60 percent core holdings and 40 percent satellites. This would follow an investment policy statement that you put in place and review once a year.

As a general rule, your core-and-satellite approach should reflect where you are in life. There is no one right approach, but those near or in retirement might want to have their satellites focus on increasing yield with vehicles like master limited partnerships or non-U.S. bonds while reducing exposure to the U.S. bond market. Younger investors might want to focus on specific promising sectors like technology or infrastructure while sampling small-cap international companies.

The number of sectors in your satellites depends upon your specific written goals and what you need. Do you have emerging markets represented in your portfolio? Is most of your stock allocation concentrated in one country or one style of investing such as mega-cap growth (think S&P 500)? Fill in the gaps with your satellites.

Here are some investments to consider for your satellites:

1. Emerging market growth for those overconcentrated in domestic markets

Since all economies are linked in some way, the economic pain of the U.S. and Europe is felt around the world. The global economy will grow at a 3.3 percent rate in 2013, according to the International Monetary Fund.

Real (after inflation) growth in Latin America, however, is expected to reach 4 percent, with resource-rich Brazil the main engine in that region.

Good vehicles to capture this growth include the EGShares Brazil Infrastructure Index fund and the PowerShares FTSE RAFI Pacific ex-Japan Portfolio. The latter fund excludes Japan, which will continue to struggle.

But there are even brighter spots: Sub-Saharan Africa is set for 5.7 percent growth next year, India for 6 percent and China for 8.2 percent, the IMF says.

2. International utilities

Given population growth, infrastructure building in developing countries is likely to continue - expect expanded utility grids, roads, water works and all of the trappings of modern civilization.

Two funds that specialize in this development are the SPDR S&P International Utilities Sector ETF and the iShares S&P Global Infrastructure fund, which also includes U.S. companies that pay steady dividends.

3. Individual countries

Turkey has been growing at more than 8 percent, which puts it in a league with China. It has a relatively young population and it poised for global trade.

You can sample the country's stocks through the iShares MSCI Turkey Investable Market Index ETF, which is up nearly 50 percent year to date through Nov. 14.

Another lesser-known growth magnet is Thailand, represented by the iShares MSCI Thailand Investable Market Index, up more than 26 percent through Oct. 30.

A third pillar of my least-heralded growth candidates is Mexico. The iShares MSCI Mexico Investable Market Index offers a sampling of global stocks such as CEMEX, the cement company, and Grupo Modelo, the beer producer. The ETF is up about 23 percent through Oct. 31.

As optimistic as I am about these countries, I also build a lot of uncertainty risk into my model. Europe is still hobbled by its debt and austerity crisis and the U.S. is trying to resolve its debt ceiling and fiscal cliff threat. These problems still may spill over into emerging markets. A renewed global banking crisis or U.S. retrenchment could darken the picture even more, so keep in mind that your satellites should not be dominant portfolio positions and long-term holds.

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