Core-satellite investing strategy: A complete guide
A core-satellite investing strategy combines passive and active elements. Majority of the portfolio is kept in index funds and the smaller portions in select investments with the aim of enhancing returns.
What is core-satellite investing?
The investment approach involves constructing a portfolio from both passive index funds and actively trading securities. The bulk of the holdings are usually held in broad market ETFs, while investors try to capture additional returns by allocating the remaining portion to specific stocks or actively managed ETF products.
The idea can be likened to the solar system. The main investment is the sun, sitting at the centre of the universe, which is much larger than the orbiting planets. The strategy aims to capture a boost in returns provided by the satellite investments.
However, they remain small enough to not significantly damage the investment portfolio as a whole if one or a few have negative performances.
This type of investment portfolio construction is a way to manage risk, with the potential to slightly outperform the market but not reduce diversification. It's adding a step to investing in one ETF and not putting all your eggs in one basket. The approach can provide a way of bridging the gap between dollar-cost averaging into index funds and picking individual stocks.
How core-satellite investing works?
Core-satellite investing involves carefully considering asset allocation. The main premise is to complement passive investments with more active decisions about which and when to trade some securities. With the core portion usually being an ETF, the majority of the portfolio's return will be in line with the stock market index it tracks. The amount of the portfolio dedicated to the core and various satellites can also be shifted over time.
The choice of other investments as satellites can either out or underperform this index over time. Shares with higher potential returns tend to come with higher risks. Investors might also decide to switch their selection of satellites occasionally. These will affect the returns of the overall portfolio, but it would normally experience lower volatility during periods of market downturns due to the large role of the core.
🎓 Learn more: Find out more about the difference between active vs passive investing→
The core part of the portfolio is often one or more broad market index funds. They're usually ETFs that track major indices like Australia's S&P ASX200 or the S&P 500 in the U.S. They are generally the most cost-efficient way to gain this level of diversification, with low fees and fewer trades being required compared to individual shares or more actively managed options.
💡Related: Learn more about how to invest in S&P 500 in Australia→
Some view multi-asset ETFs as a solution because they already contain several sectors. There are also international options, but keep in mind that these tend to also have large exposures to the U.S. and look at the details of their holdings online. There are a number of ETFs that exclude certain regions, which is an option if you'd like to restrict the risks of any one market.
Investors tend to have a bias towards their local market. For example, Australians do benefit from high dividends from ASX firms, but these represent only a small proportion of the world's total stock markets. Economic conditions and events in someone's home country are also more likely to affect them directly, which can result in more concentrated risks at times.
Many companies now have global operations, so some trends and matters like exchange rates can still affect returns. Some investors might look at ETFs that screen these stock market indices for measures like ESG factors or financial ratios. These tend to come with higher fees than broad-market ETFs, but some believe the approach pays off in the long run.
The core usually accounts for between 65% to 85% of the total investment portfolio in terms of value. There is no hard rule and the numbers can vary depending on your circumstances, as well as personal risk. The portion will also naturally drift over time as the stock market moves up and down.
The satellite portion provides investors with considerable flexibility and is where personal preferences can come through. It could make up around 15% to 35% of your portfolio in total but can shift over time. It can be built up from a smaller amount or can be limited if there is concerns about a downturn in one or more of these investments. There can be various reasons to choose a specific investment as a satellite.
They're often used to tilt extra exposure to higher growth areas, but also come with greater general levels of volatility. These can be individual stocks or ETFs focused on a specific sector, region or selection of firms. For example, investors could be interested in emerging markets ETFs, U.S. tech stocks, or looking for a high-yield ETFs.
Satellites can also be used to gain access to investments that are more different from the core. These could provide some kind of hedge during periods of market downturns or further diversification. Some might want to look at investing in gold to counter inflation and fixed-income ETFs to balance against movements in the stock market.
The selection of these investments usually takes a more active approach. You might want to take profits or shift focus over to a new sector if you think it represents better future opportunities. However, keep in mind that making trades more regularly does mean additional fees and potential capital gains tax implications.
How to implement a core-satellite portfolio into your strategy
Consider your current investments and what kind of asset allocation they represent. Think about what kind of stocks could become part of your core-satellite approach and figure out if there are any gaps. These could be your next or first investments if you're starting fresh.
It could be possible to build out core-satellite asset allocation based on your existing investment strategy. If you've got several individual stocks, it might be time to invest funds into an ETF that acts as the core. For those that have found ETFs to your liking, smaller trades could add exposure to interesting sectors, regions or blue chip firms.
The specifics of the strategy will depend on your individual preferences, financial situation and risk tolerance. It's something you can work towards over a longer timeframe, there's no need to change things and make final investment decisions overnight. You can also assess and rebalance your core and satellite approach at regular intervals.
Core-satellite portfolio examples
Here are a few ideas of investments and the asset allocations that could be used to construct a core-satellite portfolio if using ETFs. Either section of the portfolio can be made up of one or more ETFs, it depends on your personal preferences.
Core - Around 65% to 85% of the total portfolio value.
Satellites - 15% to 35%: Differing proportions can be invested in a number of satellite ETFs to make up your total satellite portfolio.
Bonds and fixed income
Active and screened products
Additional sectors to consider
Precious metals, such as gold
There are more options available on the ASX. You might also choose to look at managed funds or currency ETFs.
The above table of portfolio allocation examples is a list of the most traded exchange-traded funds (ETFs) on Stake AUS over the calendar year 2023 to 12 July 2023. They are provided for demonstration purposes only. It is not a recommendation to invest in, or opinion about, the ETFs listed. Make sure you conduct your own thorough research and analysis before making any investment decisions and consider speaking with a licensed financial adviser.
What are the benefits of a core-satellite portfolio?
A core-satellite investing strategy could provide consistent returns, without limiting the risks of seeking some additional returns. Like any investment, there are no guarantees about future performance.
With the bulk of funds going towards one or more broad market ETFs, the overall portfolio value can stay close to the stock market index. The satellites allow your personal preferences to come through and give you an opportunity to make the portfolio work towards your financial goals. Remember it's not ETFs vs stocks, but a balance of both assets to create a structured and diversified portfolio.
What are the risks of a core-satellite portfolio?
There’s always a chance that one or more components of your portfolio won’t perform in the short or long run. Focusing on one area can reduce the level of diversification in your portfolio and underperformance in this area will reduce overall returns. One of the reasons ETFs have become popular is due to active fund managers failing to beat the market for many years.
Experts with considerable experience, time and resources don’t always get higher returns than the stock market index. It might be wise for retail investors to temper expectations. There will also be periods when the core section doesn’t provide positive returns and results from the satellite portions are unlikely to be enough to sway the general performance of your portfolio.
This does not constitute financial product advice nor a recommendation to invest in the securities listed. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking appropriate financial or taxation advice before investing.
Megan is a markets analyst at Stake, with 7 years of experience in the world of investing and a Master’s degree in Business and Economics from The University of Sydney Business School. Megan has extensive knowledge of the UK markets, working as an analyst at ARCH Emerging Markets - a UK investment advisory platform focused on private equity. Previously she also worked as an analyst at Australian robo advisor Stockspot, where she researched ASX listed equities and helped construct the company's portfolios.