Core-satellite investing is an approach that marries the benefits of strategic asset allocation with the potential of market-beating returns. Commonly found in many institutional portfolios, this strategy has caught on amongst private investors. A poll found that 66% of money pros in the Financial Times 400 list of leading advisors have built some form of core-satellite portfolios for their wealthy clients.
A time-tested strategy, the core-satellite approach is especially effective for long-term investing. One way to visualize it would be to think of a planet surrounded by its moons. There is a core of long-term index investments surrounded by complementary satellite investments. These satellites offer the potential of enhanced diversification, market out performance, or both.
Therein lies its appeal: Many investors want to keep costs low and capture the market’s returns as efficiently as possible. But they also like the idea of holding a few investments that can offer the possibility of higher returns. In a sense, a core-satellite portfolio provides the best of both worlds.
Building a strong core
The ideal core is a low-cost exchange traded fund (ETF) portfolio that provides market exposure. Economically, this makes sense. You are automatically invested in hundreds, if not thousands, of securities with just one ETF. They have much lower fees compared to many active funds that invest in similar assets. Moreover, research has consistently shown that most active managers have not outperformed their index benchmarks over the past 10 years. So, why pay more?
An effective core portfolio should include both equity and bond ETFs with exposure to different sectors and geographies. This provides ample diversification while reducing stock or sector-specific risks, which in turn lowers portfolio volatility and smooths investment returns.
Adding your satellites
Satellites are portfolios or investments that typically carry more risk than the core, but also offer the opportunity for outperformance. These can include funds that tilt towards certain investment styles or sectors, as well as specific stock picks. These could be growth stocks for investors who are still building up their net worth and want share price growth, or real estate investment trusts (REITs) for investors who need income.
Some investors prefer to use actively managed funds as satellites in the belief that they can add value in more narrow or niche segments of the market. But that’s not always the case.
Nowadays, there are many ETFs that invest in certain sectors or reflect certain market trends. For example, if you believe in the growth of emerging markets, you can add an ETF that tracks the MSCI Emerging Markets index. You gain targeted exposure to emerging markets while still enjoying the low fees and instant diversification that ETFs deliver.
Is core-satellite right for you?
Core-satellite portfolios are suitable for investors of all stripes. They can be as conservative or as adventurous as you prefer – the investments you choose will depend on your individual risk tolerance, timeline and investment goals
Typically, financial advisors recommend that your core investments make up 70% to 90% of your overall portfolio. The actual splits depend on your personal circumstances, which is why an advisor can help you come up with an asset allocation that is most appropriate for your goals.
How core-satellite investing can work
Implementing a core-satellite strategy can be as simple as owning two portfolios. For the core component, start with a diversified ETF portfolio like Syfe’s Global Portfolios. They are diversified across equities, bonds and gold, and hold investments across 16 sectors and 57 countries. What’s more, these portfolios are risk-managed according to investors’ personal risk appetite.
For the satellite portion, you can go with a 100% equity portfolio. Syfe’s latest offering is an all-equity portfolio that invests in over 1,500 stocks from the world’s top companies. Called Equity100, the portfolio is made for experienced investors who are willing to face periods of significant share price volatility to achieve higher risk-adjusted returns over the long-term. To optimize portfolio efficiency, Equity100 is also built using a smart beta strategy that tilts the portfolio towards large-cap, growth and low-volatility factors.
Alternatively, consider a REIT portfolio like Syfe’s REIT+ portfolio for some real estate exposure. The portfolio tracks the SGX’s iEdge S-REIT 20 index, which measures the performance of the 20 largest REITs in Singapore.
A core-satellite approach is an effective yet interesting way of building wealth over the long term. You benefit from the steady market returns generated from your core investments while enjoying the thrill of your satellites outperforming the market from time to time. In fact, it’s a win-win-win. Better diversification, low fees and the potential for higher risk-adjusted returns.