Core Plus refers to a portfolio management strategy that employs a combination of passively managed, relatively low-risk, investment–grade bonds with individually selected higher risk instruments. The rationale behind this strategy is the reduction of costs, volatility and taxes while maximizing portfolio returns. In the Core Plus portfolio, the core holdings, comprising approximately 75 to 80 percent of the portfolio, follow leading market indexes, such as the Lehman Aggregate Bond Index or the Standard and Poor’s 500 Index. Investors in Core Plus funds hold these investments for the long term, with the intent of netting the median return produced by the instrument’s given market. Investors allocate the remaining 20 to 25 percent of the portfolio to short-term, actively managed instruments, with the opportunity for a skilled portfolio manager to outperform the market and enhance returns.
The core holdings of the Core Plus portfolio consist of traditional equity-based or fixed-income securities, such as passive mutual funds, index funds, or exchange-traded funds. Passively managed funds trade assets only when the underlying benchmarks change, meaning fewer trades with lower load fees and fewer capital gains taxes. The administration fees are also low, compared to active management fees, because the manager makes decisions only when changes occur in the index. A core mutual fund maintains a mixture of small- to large-cap funds that provide diversification through a variety of markets and jointly reflect a growth investment approach.
Periodically, market inefficiencies resulting from economic uncertainty provide opportunities for short-term investment in high-risk, undervalued securities, such as a real estate investment or a commodity option contract. The Core Plus portfolio may assign as much as 25 percent of its value to these types of investments. Projecting the risk and return of a given stock, bond, or fund is a vital part of this process. Managers must take into account the various risk factors of a given investment, including the credit rating, interest rates, liquidity, leverage, and foreign exchange risks. They must also weigh the expense ratio relative to the return, since the actual return may be dismal once the expenses of an actively traded security are subtracted.
Credit rating is a key component of resource allocation within a Core Plus portfolio. The securities tracked in the Lehman Aggregate Bond Index are largely equity-based, and funds that use this index as a benchmark will be rated AAA, the highest credit rating. Junk bonds, while bringing higher yields, increase the volatility of the fund. Foreign currency exposure, encountered with bonds denominated in foreign currency, also adds volatility and risk.