Mitigating behavioral biases with a core satellite allocation

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The following is an excerpt of ValueWalk’s interview with Mark Diorio, CFA, CIO at Brookstone Capital Management. In this part, Mark discusses using a core satellite allocation framework to manage clients portfolio. Check out the full interview on ValueWalk Premium.

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Sure, one of our tag lines is called raise, which is a guess our investment philosophy where risk appropriate investment strategy evaluation, and I think the keyword is appropriate. In other words, you don’t know what the best investment is until hindsight. But you do know what’s appropriate given an individual’s risk profile. So when we when we’re defining risk, we’re trying to get clients to their goal, taking the least amount of risk possible.

Risk Appropriate Investment Strategy Evaluation

And so we don’t want to have a portfolio that runs into what we call a permanent impairment of capital that would basically take them out off of their plan and not meet their, their goals. So we look at risk from two categories, the normal ones volatility, which is the short term risk and inflation, which is the long term risk, and a lot of times people forget about the inflation component, that that’s really more of a concern over time than volatility is.

There will be advent flows and volatility, but it’s really inflation that eats away. And so one of the baselines for investing, of course, is the preservation of purchasing power over time. Now, what one of the ways we found that’s been very helpful to manage portfolios and get clients allocated consistent with their risk profile to make sure they stick with the plan is to use a core satellite allocation framework.

So your core portfolio is really driven by your risk profile. So a lot of clients come in and they’re a moderate. And so that generally lines up with the traditional 60/40, 60% equity 40% fixed income portfolio. And we have a couple of different ways we slice that just a couple of variations of models. So we want some choice architecture, which basically says if you want a straight passive investment core portfolio you can do that. We can implement with low cost ETFs.

ETFs and asset allocation

If you want a little bit more active management in there, we can do that. But making sure it’s really consistent with what we’d expect out of a core portfolio. But then we have a component where we say, Well, if you’re going to make active adjustments, and maybe you’d be more responsive to the market environment, do that in your satellite allocation. And don’t disrupt your core portfolio because we can quantify all the risks in the core portfolio given all the history we have and market data we have.

But the satellite you can use and you can adjust exposures, and if you have a preference for a theme for example, You may want to get access to do it in your satellite allocation. And we found that to be very effective because they won’t. Investors really want to adjust their core, they’ll stick with that plan.

But they also know it’s a very flexible framework in the satellite allocation, where they’re not going to mess up the core. But they can adjust as, as they see opportunities and advisors can adjust to, you can get a little more growth oriented. With the satellite, you could get a little bit more income oriented, or a little bit more defensive if you want to and just complement your core portfolio.

Core Satellite Allocation Approach That Helps Mitigate The Behavioural Bias

Exactly. Yeah, definitely. I think that’s a real risk. It comes up all the time. And I don’t think that risk is ever going away. Yeah, it hasn’t in 20 years, and we see it every time. Volatility creeps up or the on the flip side. few weeks back from from when we’re talking today, there was a lot of speculation and hot stocks, you know a few story stocks and they were getting a little excessive.

And we actually put out a note just to say, you know, some of these moves are not normal and abnormal events happen in the market to the upside, just warning against chasing the hot stocks when they happen to be hot stocks because every bull market has hot stocks, making change from time to time. But that’s a normal part of a bull market. You have some leaders that help take it higher and drive higher.

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About the Author

Jacob Wolinsky
Jacob Wolinsky is the founder of ValueWalk.com, a popular value investing and hedge fund focused investment website. Jacob worked as an equity analyst first at a micro-cap focused private equity firm, followed by a stint at a smid cap focused research shop. Jacob lives with his wife and four kids in Passaic NJ. - Email: jacob(at)valuewalk.com - Twitter username: JacobWolinsky - Full Disclosure: I do not purchase any equities anymore to avoid even the appearance of a conflict of interest and because at times I may receive grey areas of insider information. I have a few existing holdings from years ago, but I have sold off most of the equities and now only purchase mutual funds and some ETFs. I also own a few grams of Gold and Silver

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