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Investing strategy: Core and explore investment approach

June 17, 2024
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Finsesh
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Finsesh

A one size fits all investment strategy. Keeping it simple.

I first heard of the term core and explore in one of Tony Robbins' money books, and it stuck. The term is based on the original investment strategy called the core-satellite approach, but for the reason that it sounds better, we will use core and explore as the principles are the same.  

This is a strategy that can be followed by the investor starting or an advanced investor. So whatever level of expertise you have, let's dive right in.  

 

Active vs passive investing

The age-old argument of active vs passive management. Over the years the investment world debated this to great lengths, discussing topics such as which would be better in a bull or bear market, fees, and long-term performance. It seems that votes in the western world are in and the market is showing us, by way of asset flows, what it decided. 

 

What is active investment management? 

Active managers have a goal to outperform the market over time. By using their investment philosophy they mainly buy and sell asset classes to over-and under-weight their position relative to the market and hopefully beat the market.

 

What is passive investment management? 

Passive managers also called index managers aim to provide the return of the market. Their philosophy aims solely to provide market returns. Some managers might have some extra strategy to give investors market returns and a bit more.

 

Results over time? 

As confirmed by this CNBC article there might be short-term outperformance of active managers over the market (S&P 500) but in the long run, the truth comes out, showing that 84% of active managers underperform the market after 5 years, this number jumps to 90% after 10 years and 95% of managers underperform the market over 20 years. The results in S.A. aren't much better and the divergence away from active management has not taken place similar to the flows in the USA as can be seen in the graph below. 

 

Why index investing? 

There are clear differences between these two investment strategies. 

-The reason most people invest in index funds is due to the low fees, but these index funds will always underperform the market by the fees they charge in the fund. 

-Index investors believe that over the long run active managers can't beat the index so why overpay for underperformance? 

-Index funds provide less investment flexibility than active managers, but still provide good diversification.

-The other big benefit of index investing is that it is self-cleansing, meaning the winners remain in the index and the losers are automatically kicked out of the index, which minimises the stress for the investors of having to avoid losers and picking the winners. 

John Jack Bogle the founder of the Vanguard group said: Don't look for a needle in a haystack, just buy the haystack. 


 

Another serious statement backing index investing was when Warren Buffett wrote that when he passes away, his advice to the trustee is put 10% of cash in government/short-term bonds and 90% in a low-cost SP500 index fund (Vanguard)

Now that we know more about active vs passive investing, let's look at the core and explore investing approach and how this method clouds potentially assisting you as an investor. 

 

What is Core-and-explore investing approach

The core-and-explore investing approach solves the age-old argument between active and passive management as it is a mix of passive and active management. The idea is to have a strong underlay of low-cost index funds(70%) that provide market returns and blend more active investments(30%) with the index fund which should hopefully give an index-beating performance. 

NB: If you are new to investing, stick to index funds. It might not be as sexy, but it will get the job done. Once your experience increases you might want to add to your explore holdings. 

Core: As the core holding in any portfolio, you want to invest about 70% in a low-cost index fund. The benefits are the low costs, broad diversification, less anxiety of choosing winners or avoiding losers and they are self-cleansing, meaning the winners stay in the index and the losers fall out. 

Explore: For the explore part you can choose an active manager that will hopefully add alpha above the market index. Since picking the right manager has its risks, we recommend keeping this to a minimum as it is a more stressful form of investing. There is no prerequisite to have the explore part of your portfolio, it's just for those who want to dabble outside of the low-cost tracker funds.

 

Summary: 

The investment media shows us that day trading and instant gains are the norms when investing when actual good investing is very boring to watch. Good investing is like a bar of soap, the more you touch it the less it becomes. Using the core and explore investing approach will provide a bulletproof strategy to build an investment portfolio over time. 


 

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