The traditional way to construct a core portfolio is with low-cost, widely diversified funds that represent large swaths of the market for the lion’s share of a portfolio’s assets. The idea is to access market exposure in the core portion, what’s known as beta. Index mutual funds and exchange-traded funds are a low-cost way to access passive strategies, giving investors exposure to hundreds, if not thousands, of securities with one purchase.
“There are active funds out there trying to do the same thing but with some outperformance potential,” said Iachini. “Of course, there’s an added cost if you do that.”
Investors who practice this approach say that 75 percent to 90 percent of the portfolio should be held in these types of investments.
With the explore portion, on the other hand, investor seek to gain an outperformance edge or they might want to express a conviction about the market, perhaps believing technology will continue its strong run or that international markets might edge out domestic ones given their slimmer valuations.
Actively managed funds are therefore used most often used for this portion of the portfolio. There’s a widely held belief that managers can add value in smaller, less followed parts of the market. But that’s not always the case. Because ETFs, and even some mutual funds, can invest in narrow slices of the market, it’s possible to use passive funds for the satellite portion, too.
For example, an investor who wants to take a bet on emerging markets could use an ETF that tracks the MSCI Emerging Markets index. Someone who believes that biotech is poised to outperform could buy an ETF that follows the Nasdaq Biotechnology index.
“Investors buy around the markets as their views change,” Iachini said.