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Core Satellite Investing Approach

April 17, 2017
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The Core Satellite investing approach provides a framework for investors to allocate their investments across different asset classes, investing strategies and instruments.

An Investment Plan can be formulated using the Core Satellite approach that ensures structure, rigour, process, appropriate capital allocation and personalised risk management according to a prepared plan rather than deferring to gut feel and social defaults, such as balanced mutula/managed funds where 75% of workers’ long-term core investments reside.

The Core Satellite approach has two key segments:

  • a passive or near-passive portion called the ‘core’, which should have at least 50% of capital allocated to it, and
  • a ‘satellite’ portion, which is more active and has less capital than the ‘core’ portion allocated to it.

The ‘core’ portion deploys strategies that should at least match the performance of the stock market, while the ‘satellite’ portion of capital deploys strategies that can provide higher returns than mainstream stock market indices, and hence better than the ‘core.’ Combined, the two portions should outperform the market while still limiting risk, so the overall risk-adjusted-return is improved.

The ‘core’ can be 100% of investing capital and the ‘satellites’ 0% on occasion, or all of the time, the mix depending on a number of criteria including an investor’s objectives, return goals, regular time availability for investing, age, investing strategy horizon, tolerance for risk and the amount of capital that is invested.

Typical Core Satellite Approach

Core portion

The ‘core’ portion comprises securities that are typically passively managed, such as index ETFs, passive index mutual funds and individual large-cap stocks that pay good dividends. Investment real estate, residential or commercial, could also be included in the ‘core’.

The performance of the ‘core’ portion can be compared against a benchmark as an objective indication of the availability of returns, such as the ASX 200 Accumulation index or the S&P500 Total Return index.

The strategies in the ‘core’ portion will typically have a strong bias towards an investor’s goals and objectives, such as large and mid-cap index funds/ETFs and large/mid/small-cap growth companies if the aim is for growth. However, if the aim is for regular income then perhaps the ‘core’ strategies could include large-cap high dividend yield stocks, bonds (corporate and government), listed real estate investment trusts that pay good quarterly dividends, high yield ETFs or even unlisted commercial property.

In the ‘core’ the emphasis is on passive, or near-passive, investing.

Satellite portion

The ‘satellite’ portion comprises strategies and securities that the investor envisions will do better than an accepted market benchmark. Base these strategies on evidence emanating from research rather than only on hearsay, advertising or opinionated commentary.

Strategies may include actively managed stocks, writing covered call options, boutique active mutual/managed funds, rotating sector ETFs, international index ETFs or passively managed assets with a particular style that is different from the ‘core’ style aimed at enhancing the bias of the ‘core’.

The emphasis is on using an active approach that has an edge and hence a higher probability of growing the ‘satellite’ portion of capital by more than the ‘core’ portion, or passive portion, in a timeframe that meets the investor’s objectives.

Active means that buying and selling, or rebalancing, will occur based on some timing criteria with the option to be 100% in cash, when appropriate, according to the timing model. Timing allows the investor to outperform the market by protecting investment capital during severe bear markets, of at least -30% to -55% declines, and to take better advantage of rising markets by actively focusing on the cream of the crop.

The ‘satellite’ portion may be allocated 100% to domestic and international equities strategies and alternative strategies such as futures, commodities, options, FX or even exotic investments such as vintage cars and art. Deciding which asset classes to include will depend on investors’ interests, capital, time availability, goals, tolerance for risk and investing skills.

The stocks and ETFs in the ‘satellite’ can be the same as those in the ‘core’ but using an active strategy rather than a passive, or near passive, strategy.

The ‘satellite’ portion should improve the return and reduce the risk of the overall allocation of investment capital to this particular Core Satellite portfolio. Achieve this through low-correlated strategies, short and medium-term investment methods, and applying market risk (systematic risk) timing techniques that are typically different from those in the ‘core’ portion, but still consistent with the mission statement and goals and objectives of the Investment Plan.

Core Satellite Considerations

The Core Satellite investment approach allows investors to construct many permutations of differing strategies and instruments. Various ideas and examples could include:

  • A long-term stock market focused strategy for the core, and more aggressive active short, medium or long-term stocks strategies for the satellites.
    • The long-term equities core portion could be achieved using index funds (index mutual funds or index ETFs) and/or large-cap ‘blue chip’ stocks that have a very low probability of failing, emphasising the reinvestment of dividends and franking credits.
    • Commercial and residential real estate could be used for a portion of the core capital if an investor has experience in this area and sufficient capital.
    • The satellites could deploy timing on index ETFs/funds or directly in stocks with strategies focused on varying time frames.

  • For the core: a long-term combination of passive equities and bonds; for the satellite portion: active commodities, stock market sector strategies, corporate bonds, FX, Futures, direct stocks strategies and ETO (Exchange Traded Option) strategies.

  • Treasury bond funds, Treasury Inflation Protection Securities (TIPS) – for U.S. investors – and fixed interest could be used as part of the core to ensure a “safe” level of cash flow and use stock and commodities strategies as satellites for growth.

  • The use of some leverage in one or more of the satellite strategies with timing. Note: leverage should not be used for equities strategies without also using timing otherwise the investor could become a forced seller due to margin calls during a severe bear market.

The following diagram shows sample Satellite strategies positioned around sample Core strategies.


Figure 1

The percentage of the portfolio allocated to the core portion is a variable; there is no set percentage except that the core portion must be larger than the total of the satellites, therefore greater than 50%.

There is also no set quantity for the number of satellites except that the investor must be able to monitor the holdings practically from a time and skills perspective. Each satellite should be large enough to play a meaningful role but not so substantial that it can have a large adverse effect on the performance of the core. In other words, the losses in any single satellite should not have the potential to derail the entire portfolio from achieving its long-term investment goals and objectives.

A satellite ‘shut-off valve’ could be used too, which could be determined by measuring the percentage fall of all or part of the satellites’ combined performance from a particular point such as a recent peak in the equity curve of the entire Core Satellite portfolio.

The underlying theme of the Core Satellite approach is
to use the satellite portion to take bigger risks for growth with a smaller portion
of the portfolio investment capital.

The key to a Core Satellite approach is to have the satellites complement the core without significantly altering either the risk or the growth potential of the overall portfolio. The satellites should provide better opportunities for more growth and less correlation to the core. If the satellites don’t potentially offer more growth, then the capital should be transferred back into the core portion.

Complexity and effort for the individual investor increase with the number of satellites. Consequently, when determining their Core Satellite structure, investors should be realistic about their skill levels and time availability.

If investors evaluated all strategies that they are using and may consider in the context of the Core Satellite framework, their overall investing perspective should improve such that the appropriate priority is given to each strategy that is consistent with the investor’s Investment Plan.

Most traders put far too much focus into satellite strategies to the detriment of their core investments. Around the western world nearly every working person has a core investment through their regular contributions to a ‘defined contribution’ retirement scheme, viz., superannuation, 401(k) and pension.

All too often investors spend an inordinate amount of time devising, trading and gaining skills in satellite strategies while their core investment, their long-term retirement nest egg, produces relatively pathetic long-term returns in a balanced managed fund that is hugely underperforming the stock market indices. This will probably leave them multiple hundreds of thousands of dollars worse off in retirement someday because they spent so much time stroking their ego trying to achieve big gains on small amounts of capital that in the big scheme of things will leave them worse off in the long term.

Sweat the big stuff first. Using the Core Satellite approach will help you structure your investments so that you get your core investments working the best that they can before bothering with satellite strategies.

Author of Blueprint to Wealth: Financial Freedom in 15 Minutes a Week & Founder of Share Wealth Systems

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