Core-satellite investing is a portfolio management approach that involves dividing a portfolio into two parts: a core portfolio of diversified, low-cost investments and a satellite portfolio of more focused, higher-risk investments.
The core portfolio is typically made up of broad-based investments, such as index funds or exchange-traded funds (ETFs), that provide broad market exposure and are designed to deliver less volatile returns over the long term. On the other hand, the satellite portfolio is made up of more focused investments, such as sector ETFs or individual stocks, designed to attempt for higher returns with accompanying higher risk.
The core portfolio is expected to provide stability and consistency. In contrast, the satellite portfolio is expected to provide an opportunity for higher returns through specialised investments, such as sector ETFs or individual stocks.
Different types of core-satellite investing
- Passive Core-Active Satellite: In this type, the core portfolio is made up of passive index funds or ETFs, while the satellite portfolio is made up of actively managed investments.
- Regional Core-Sector Satellite: In this type, the core portfolio is made up of investments that provide broad exposure to different regions or countries, while the satellite portfolio is made up of investments that focus on specific sectors or industries.
- Active Core-Passive Satellite: In this type, the core portfolio is made up of actively managed investments, while the satellite portfolio is made up of passive index funds or ETFs.
- Quantitative Core-Qualitative Satellite: In this type, the core portfolio is made up of quantitatively driven investments, such as factor-based or systematic strategies, while the satellite portfolio is made up of stocks selected based on qualitative factors such as a company’s earnings growth, management quality, and industry trends.
- Market Capitalisation Core-Style Satellite: In this type, the core portfolio is made up of investments that provide broad exposure to different market capitalisations, such as large-cap, mid-cap, and small-cap, while the satellite portfolio is made up of investments that focus on specific investment styles, such as growth or value.
Note that our writings on core-satellite investing do not refer to the ‘active core-passive satellite’ and ‘quantitative core-qualitative satellite’ types.
History of core-satellite investing
The concept of core-satellite investing has its roots in modern portfolio theory (MPT), which was first introduced by economist Harry Markowitz in the 1950s. MPT suggests that investors can achieve better risk-adjusted returns by diversifying their portfolios across multiple asset classes and investment styles.
The core-satellite approach to investing was popularised in the 1980s and 1990s as a way for institutional investors to allocate assets efficiently and reduce costs.
The core-satellite approach gained popularity among retail investors in the 2000s (a) as more low-cost index funds and ETFs became available; and (b) as investors became more aware of the benefits of diversification and passive investing. Today, core-satellite investing remains a popular strategy for individual and institutional investors alike.
Advantages and disadvantages of core-satellite investing
- Diversification: Core-satellite investing allows investors to achieve a high level of diversification by combining a broad-based, low-cost core with a smaller number of more specialised investments.
- Lower costs of the core: By constructing a portfolio with a passive core and a smaller number of more expensive satellites, investors can reduce their overall cost of investing because the core will typically have lower expenses than the satellites.
- Flexibility: The core-satellite approach provides excellent flexibility, as investors can choose from a wide range of core and satellite investments to match their investment goals and risk tolerance.
- Complexity: Core-satellite investing can be more complex than a simple, passive investment strategy, as investors need to manage both the core and satellite investments.
- Active management risk: The use of actively managed satellites can introduce additional risk into the portfolio, as the performance of these investments is subject to the skill and experience of the fund manager.
- Active management cost: Actively managed satellites can be more expensive than passive investments, which can erode returns over time.
As with any investment strategy, the specific benefits and drawbacks will depend on the individual investor’s investment goals, risk tolerance, and investment strategy.
Core-satellite investing and long-term investing approach
Core-satellite investing can be either a short-term or a long-term investing approach, depending on the specific investments chosen and their investment time horizon. The core of a core-satellite portfolio is typically composed of low-cost, passive investments that are designed to provide broad-based exposure to the markets over the long term. As such, a core-satellite portfolio can be well-suited for long-term investors.
However, the satellites in a core-satellite portfolio can be either passive or active investments and can be designed to provide exposure to specific investment trends or market sectors. These investments may be more speculative and may have higher risk and volatility than the core of the portfolio. As a result, the performance of the satellites can be more influenced by short-term or mid-term market movements and may not be suitable for all long-term investors.
Proportion of core and satellite investments in a core-satellite portfolio
The proportion of core and satellite investments in a core-satellite portfolio can vary widely depending on the individual investor’s goals, risk tolerance and overall investment strategy. In general, the core of the portfolio is typically composed of a larger percentage of the portfolio, while the satellites make up a smaller portion of the portfolio. For example, a typical allocation for a core-satellite portfolio might be 80% core and 20% satellites.
The specific allocation of core and satellite investments depends on the investor’s goals, risk tolerance, and overall investment strategy. Regular rebalancing of the core-satellite portfolio can also help to maintain the desired allocation of core and satellite investments over time.
Play money as part of the satellite portion of core-satellite investing
Play money refers to discretionary funds or investments with very high risk, uncertainty or illiquidity. An investor can consider setting up play money only if she has the financial strength and appetite to easily withstand the loss of that entire amount in the worst-case scenario. In the context of core-satellite investing, these types of investments can be considered a part of the satellite portion of the portfolio.
Illiquid investments as part of the satellite portion of core-satellite investing
The satellite portion of a core-satellite portfolio can contain illiquid investments. Illiquid investments, such as private equity or real estate investments, can be included in the satellite portion of a core-satellite portfolio to provide access to these asset classes.
However, it is essential to remember that illiquid investments can come with potentially longer holding periods than more liquid investments. These characteristics of illiquid assets make them less suitable for short-term investors or those who may need to access their funds quickly in an emergency.
Reception of core-satellite investing among financial advisers
Core-satellite investing has been well-received by many financial advisers and is widely used as an investment strategy among professional investors. Financial advisers appreciate the fact that core-satellite investing provides them with the ability to incorporate different investment styles and philosophies into their portfolios.
However, like all investment strategies, core-satellite investing has advantages and disadvantages, and financial advisers must carefully consider the risks and benefits before making recommendations to their clients.
Our view at QuietGrowth
To know about our view at QuietGrowth regarding core-satellite investing, refer to the ‘Forming the core of core-satellite investing‘ section in our Investment Methodology page.
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