CREATING CORE-SATELLITE
PORTFOLIOS

When it comes to protecting your portfolio while trying to get the best possible return on your investments, there are several strategies to choose from.  One strategy is the core-satellite investment strategy. Discover how to build and manage a core-satellite investment portfolio in this guide.

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The core-satellite approach is a long-term investment strategy that aims to provide a better return than the overall stock market, without exposing you to a higher level of risk than you are comfortable with. It is designed to keep volatility and costs as low as possible. 

But how does this strategy work, and how can investors utilise it to protect their portfolios while optimising the potential for it to make returns? This article will explore some critical considerations, including risk appetite, investor profile and portfolio diversification, aiming to provide a comprehensive overview of how to build and manage a core-satellite investment strategy.

What is a core-satellite investment strategy?

A core-satellite investment strategy is a highly diversified way of investing that includes dividing your portfolio into two sections, and splitting your active and passive investments into “the satellite” and “the core,” respectively.

In this strategy, the  core constitutes the largest part of the portfolio and generally consists of passive investments such as index funds. The satellite, consisting of investments that are more actively managed, is typically the smallest part of the portfolio. This part can be adjusted or rebalanced as much or as little as any investor might like, allowing them to react to emerging market trends.

Using a core-satellite investment strategy can help to create a well-balanced and diversified portfolio. By allocating your capital into different sections, each managed differently and with distinct goals, this approach offers flexibility. 

Instead of dictating specific assets, the core-satellite strategy will guide you on what types of assets work well in each section, leaving the overall decision about what exactly to invest in up to you.

How to select a core investment

When considering how to select a core investment, it can be useful to base your decisions on the foundational knowledge of what a core investment is (or should be).

Essentially, in a core-satellite strategy, the “core” is the passive element of a portfolio. The main goal of the core is to obtain a diverse set of assets that can be managed passively, optimising portfolio performance while adapting to your financial goals.

So, while some investors opt to construct their “core” through passive real estate investments, others decide to track the major indices (in the medium and long term). 

This is typically done through stable and low-fee instruments such as index funds and passively managed exchange-traded funds (ETFs). These broad market indexes are referred to as “core equity funds.” 

Remember, you should be looking for a passive investment that you can hold for the long term, without the need to rebalance regularly or make major changes.

Drawing on asset allocation guidance from BlackRock, eToro offers a series of carefully curated core-based strategies, each designed to guide capital allocation with a certain type of investor in mind (according to their approach to growth, stability and risk management), while considering the global economy and changing market conditions as well.

You may be wondering about the potential or viability of passive investments to bring about good returns, especially as traders typically tend to focus on active investing as a strategy to maximise profits. But rest assured, using passive investing as your primary investing style also has the potential to bring about very respectable (and potentially more stable) returns.

For instance, consider the S&P 500 Index. Over the last 20 years, we see that it has produced average returns of over 7% a year.

How to select a satellite investment

While it does slightly prioritise passive investments, a core-satellite strategy also utilises short-term investments, attempting to beat the market with part of its allocation. This part of a portfolio, known as the “satellite,” is the volatile part. 

The satellite can consist of any combination of investments, ranging from assets such as stocks, ETFs, bonds, cryptocurrencies or commodities to other  alternative investments across various sectors, themes and geographies.

Since satellite investments are selected with the criteria of investments that have the potential to provide an attractive return in the short term, some investors think that there is a high degree of flexibility available when choosing satellite investments. With this in mind, most investors opt to select satellite instruments by theme, rather than by specific instrument. 

Subsequently, this is the part of a core-satellite investment strategy that requires more of your time and attention. To maximise your potential for gains, a certain level of active management is required, as satellite investments attempt to outperform the broader market through asset selection and market timing. 

While their potential for attractive returns might be greater than passive investments, satellite investments typically have higher risks and costs attached, which can reduce their tax efficiency potential.

Core vs satellite investments

“Core” Investments	“Satellite” Investments
Passive approach	Active approach
Pursues market-like returns	Seeks to beat the market
Long-term focus	Short-term focus
Lower risks and costs	Higher risks and costs
Better tax efficiency	Worse tax efficiency

How to design a core-satellite portfolio

Designing and constructing a solid core-satellite portfolio is the key to getting a worthwhile investment. But where to start? Generally, successful construction includes following the 70-30 rule; by allocating 70% of the portfolio’s total capital into the “core,” and the remaining 30% into the “satellite.”

The 70% of capital in the “core” should be made up of passive investments that track the markets, with ETFs and index funds among the most obvious choices. This section is generally designed to be left alone and relatively untouched for a long time, unless a major market or macroeconomic event occurs that causes you to change your tactics. The 30% of capital in the “satellite” portion can then be made up of higher-risk investments.

While the tried-and-tested 70-30 split remains the best idea for the majority of investors, depending on your risk tolerance and investment style, you might choose to adjust the split ratio. 

For instance, those with a lower risk tolerance may consider changing the ratio of core to satellite to an 80-20 ratio, respectively. Equally, investors with a higher risk appetite might consider a 60-40 ratio instead, for the chance to optimise a portfolio for potentially larger returns.

Another incentive to tweak percentages could be a lack of time or desire to actively manage the satellite portion of your portfolio. This might incentivise an 80-20 split, instead, or encourage periodic rebalancing.

The satellite portion of your portfolio construction should also be reactive to market trends. For instance, being reactive to market cycles and trends around various, more volatile assets such as cryptoassets might indicate good (or bad) opportunities for investment.

What are the benefits of building a core-satellite portfolio?

Once you have decided on the asset allocation of your portfolio following the core-satellite approach, and regardless of how well you do with market timing, there are some inherent benefits of this strategy that you should take into account:

• Versatility
• Attractive costs
• A chance to beat the market
• Synergy between active and passive management
• Reduced risk of market timing and emotion-led investing

Versatility

First of all, this is a very versatile type of investment strategy that allows you to combine long-term stability with short-term investments that potentially offer higher profit potential from multiple sources. You can also change the percentage in each section to meet your financial goals, as they change over time.

Attractive costs

The second of the largest benefits of a core-satellite approach is that you won’t pay as many commissions as with other investment strategies. With 70% of the portfolio made up of passive instruments, this keeps the overall costs low.

A chance to try and beat the market

With this strategy, you will give yourself the opportunity to outperform the market. The “core” of your portfolio, in theory, will be stable and behave in a similar way to the market in general, while the “satellite” investments will be able to produce better short-term, although more volatile, returns.

Synergy between active and passive management

The combination of low turnover instruments in the “core” section with high turnover investments in the “satellite” section gives you a portfolio that is easier to manage in terms of active vs passive management. It is also worth bearing in mind that you can mix passive indexing with active participation, which are two complementary investment methods.

Reduced risk of market timing and emotion-led investing

The core-satellite approach removes the desire to attempt to time the market, and,  thereby, the risk of closing positions when the market is down (and vice versa). The core provides a stable base that can help investors to remain calm during market downturns, reassured by the knowledge that their core investments are designed for long-term growth and are less affected by short-term fluctuations. In addition, because the satellite is a smaller portion of their portfolio, there is less pressure on these investments to perform immediately or spectacularly, which can further reduce emotional decision-making.

Final thoughts

Ultimately, the core-satellite strategy provides a solid framework for constructing and managing a well-balanced investment portfolio. By combining lower-risk core investments with higher-risk satellite holdings, this approach aims to outperform the broader market.

While it may seem daunting initially, the key to success lies in striking the appropriate balance between the core and satellite components of your portfolio. By doing so, you can cultivate a potent core-satellite investment methodology tailored to your individual financial goals. 

Use the eToro Academy to learn more about investment strategies and techniques for portfolio management.

FAQs

What are the risks of a core-satellite portfolio?

As with all investment strategies, core-satellite portfolio management has inherent risks attached. The risk of duplication or overlap between core and satellite investments is something to keep an eye on, as is the risk of complexity creep if you attempt to manage multiple satellite positions at once. The underperformance of either core or satellite holdings could also reduce overall portfolio performance.

Why is it important to adjust a portfolio?

Portfolio rebalancing is important because it allows you to track the performance of your investments, thus, ensuring that they are still performing in line with your financial goals. In addition, it prevents major changes in asset allocation and risk tolerance from taking place.

How often should I adjust my portfolio?

Rebalancing should be addressed at acceptable intervals, depending on your investment strategy. Typically, this is done once a quarter, although many investors choose to adjust their portfolios semi-annually or even annually. You may also consider rebalancing your investments after a major change in the markets, or when you have significant savings that you want to invest.