Are you new to investing in Kernel funds and looking at which funds to start with? Or have you been a Kernel investor for some time, and looking at how you can create a well-rounded, diversified portfolio of funds? Whichever you are, it’s important to have an understanding of how the funds can fit together to ensure you’re well diversified and not overconcentrated in particular industries, markets or companies.
We recently welcomed our 11th fund into the Kernel family, the NZ ESG 50 Tilted fund, which rounded out our new sustainable fund series. Whilst we’ve covered off specifically how sustainable funds can fit into your investment portfolio, we thought we’d extend the conversation out and look at how, collectively, all our funds can fit together.
First, a few investment portfolio basics
Before understanding how the Kernel funds can fit together, it’s a good idea to know why you’re investing, what your investment horizon is (basically when you’ll need the money back and whether that is fixed or not) and whether have a feel for your appetite for risk. Understanding yourself, your goals and reason for investing will help you determine the most suitable fund to invest in.
Then there’s the cost of accessing and holding investments – management and transaction fees – or the opportunities it presents (e.g. investing for long-term growth vs in high-yielding companies where you want the profits as dividends rather than companies reinvesting it in their growth and expansion). To dive deeper into these considerations from an index fund perspective, read our full blog here.
Building a portfolio with a core-satellite strategy
If you’ve read a few of our blogs already, you’ll know we’re big advocates for a core-satellite investing approach. In fact, we base our investment approach at Kernel around it.
What’s a core-satellite investing strategy? It’s where 80-90% of your portfolio is invested in broadly diversified low-cost index funds – the “core”. The other 10-20% is invested in “satellites” which can be more speculative investments, such as individual stocks, thematic funds and more.
Sounds great in theory, but what about in practise? Let’s take a look at how you can split the Kernel funds according to this strategy…
Investments that are considered core are generally weighted by size (largest listed companies getting the most weight) and well diversified across industries.
There are no hard rules, but 20 is about the minimum number of companies needed in a core fund to be sufficiently diversified. They’re expected to provide some exposure to most aspects of the economy, from defensive stable sectors like utilities and materials, to more cyclical sectors like communication services and consumer discretionary. You can find a description of the 11 major industry sectors here.
We consider NZ 20, NZ 50 ESG, NZ Small & Mid Cap, Global 100 and the Global Dividend Aristocrats to be core funds. While the Global Dividend Aristocrats fund isn’t weighted by the company size, it is weighted by the dividend yield, with country and sector concentration limits to keep diversified.
As of 31 July 2021, it had an allocation to all 11 sectors, with the greatest concentration in Financials (25%), Utilities (18%) and Real Estate (13%). This isn’t surprising given the yielding nature of these sectors. For an investor with a higher demand for yield (normally older, looking for a passive income), the Dividend Aristocrats Fund is a suitable core investment for the equity portion of their portfolio.
Kernel funds that can act as satellites are the S&P Moonshots Innovation, S&P Kensho Electric Vehicle Innovation and S&P Global Clean Energy funds. All three of these funds are thematic and follow a particular theme or sector. You might also choose to hold a few favourite individual companies which you feel might outperform the rest, but beware history and evidence is generally against you.
The amount of which you choose to allocate of your portfolio to thematic funds or individual companies is ultimately a personal choice. It is by nature speculative and lacking proper diversification.
We’ve found some investors like to follow the more traditional core-satellite approach of allocating up to 10% of their overall portfolio to each satellite, to tilt towards a belief in these themes. Then there are some investors who have a high risk tolerance (for market fluctuations, not permanent loss) and a long time horizon, who prefer to allocate a larger portion to speculative investments, or thematic funds.
A reasonable equity portfolio for a 40-year-old following an 80/20 core-satellite strategy with no expected short term need for withdrawal might be:
Please note: This article is not intended as financial advice, just contains some ideas and investment strategies for illustrative purposes as it do not consider the suitability to your personal situation.
Chief Operating Officer