How to Build a Core-Satellite Investment Portfolio?
Creating and managing a good investment portfolio is every trader’s dream. It is not for less, since the benefits to be obtained ultimately depend on it. Building the ideal portfolio is not an easy task, since it must adapt to our risk appetite and our investor profile and, obviously, bring us positive returns. So, to create a good investment portfolio, it is essential to be familiar with some of the main strategies for building investment portfolios.
Today we introduce you to one of the best-kept secrets of investment fund managers and seasoned traders in financial markets: the Core-Satellite investment strategy. If you’ve ever heard of it but found the name complicated, don’t worry and read on. You will see how at the end of this article you want to put it into practice since it offers a number of advantages that make this one of the investment portfolio creation strategies most appreciated by investors.
What is a Core-Satellite investment strategy?
Do not be scared by the Anglicisms, you will see in a moment that it is not so difficult to understand what a Core-Satellite type strategy consists of. It is an investment management style based on dividing our portfolio into two differentiated and asymmetric capitalization parts: a larger one that we will call the core and a smaller one that we will call satellite ( Satellite). Below, we explain in detail what these two parts consist of separately and you will quickly understand how they work in binomial.
What is a Core investment?
Before explaining what the Core-Satellite investment strategy consists of, it is important to first understand what the Core investment consists of. When we talk about a Core portfolio, we mean that it is made up of passively managed indexed assets, such as the ETFs offered by eToro. The objective of a Core investment is to achieve as faithful a replication as possible of the main financial markets, with very low commissions and a minimum need for active management. With this strategy, we will build a portfolio made up of multiple assets that have the same common denominator: passive management.
Although many market traders embark on purely active investment management, the truth is that investing in products such as stock indices or ETFs has delivered astonishingly positive returns over the years. For this reason, they should not be disregarded. For example, in the last 20 years the US benchmark stock index, the mythical S&P 500, has offered annualized returns of more than 7%. If we add to this the mathematical benefits of compound interest, we will see that the purchase of indexed assets and their maintenance in the long-term portfolio can give us great joys as investors.
What is a Satellite investment?
By Satellite investment is understood all that in which the trader hopes to beat the market, that is, to exceed the returns of the financial markets. This requires active management and a careful choice of the assets in which we are going to invest our money. It is about investing in all kinds of assets (stocks, funds, high-yield bonds, cryptocurrencies, precious metals, etc.) that offer attractiveness and real possibilities for short-term appreciation.
It should be noted that short-termism is one of the main differences in relation to Core investment. For example, a trader who had identified the potential of cryptocurrencies in 2017 and decided to allocate his Satellite investment capital to bitcoin would have done well to rotate his position as queen of cryptocurrencies began to show signs of weakness. In Satellite investing, it is very important not to marry open positions.
How do you design a Core-Satellite portfolio?
To start building our first Core-Satellite investment portfolio, we can use the 70-30 rule (70% of our capital allocated to the Core and 30% of our capital allocated to the Satellite ). The Core section would be made up mainly of quoted indices, ETFs, and similar products, intended simply to track market movements. We can choose national and international indexes, depending on our personal preferences and analysis. Remember that the risk is not the same if you trade indices from developed economies, such as the US S&P 500 or the German DAX 30, as it is if you target the selective of emerging economies. Keep it in mind!
Once included in the Core allocation of our portfolio, we will keep these assets on a low turnover. That is, we will not undo these positions unless there is an unexpected event or a clear trend change. In this way, we will save commissions and tax expenses, at the same time that we will consolidate the foundations of our Core-Satellite strategy. With this Core allocation of our portfolio, we seek to follow the natural movement of financial markets because historically they have produced very positive results, especially in long time horizons, as we have seen before in the case of the American stock market.
The Satellite section, meanwhile, would consist mainly of sector assets that promise growth above the benchmark or reference stock index. For example, we could go for a Satellite segment made up of shares in the video game industry, which is offering compound annual returns of over 9%. If you have more exotic tastes, why not go for the growth of the blockchain sector with its crypto revolution?
We could also opt for other fast-growing technology sectors, such as that related to the new 5G communications technology. Or perhaps invest in a company in sectors that are so thriving in recent years such as biotechnology or pharmaceuticals.
And if you prefer something more traditional like value investing, scrutinizing the markets for undervalued stocks can go a long way in creating your Satellite allocation. Even looking for high yield or high yield bonds can give your strategy a good boost!
As you can see, the options are vast, and choosing one or the other will depend entirely on your appetite for risk and your investor profile. In any case, the percentage allocated to the Satellite part of your investment portfolio should not exceed 30%, unless you are an expert. This ensures that even in the event of mistakes in the selection of assets Satellite destruction is contained.
What are the benefits of building our own Core-Satellite portfolio?
At this point, you will have seen that designing your own Core-Satellite investment portfolio is less complicated than the name might imply. But perhaps you have not yet realized the many advantages that betting on this investment strategy offers you.
Versatility is one of the main assets of the Core-Satellite approach. In a single portfolio, it is possible to combine the stability of long-term investments and the dynamism of more specialized short-term investments. In this way, we will be able to benefit from several points of attack in the same strategy and all this with a risk distributed among several assets. Ultimately, we will achieve a degree of diversification impossible to obtain in a strategy of mere replication of a given stock index.
2. Attractive costs
One of the biggest headaches for investors is that of commissions that end up eating up the profits. And more than once they verify how a valid a priori strategy ends up not being profitable because of exorbitant associated expenses. The Core-Satellite strategy comes to the rescue of all these operators. The portfolios that adopt this approach, as they are mainly made up of indexed assets under passive management, present very low and manageable costs in the operation. The main commissions come from the minority percentage of the purchase and sale of assets under active management, which is offset by the savings produced in the passive management part.
3. Possibility of beating the market
Beating the financial markets is difficult, though not impossible, as shown by some of the best investors on eToro. The Core-Satellite investment strategy is one of the ones that offer us the most possibilities when it comes to achieving this feat. On the one hand, the Core allocation (majority) offers solidity while replicating with great fidelity the organic movements of the markets. On the other hand, the Satellite allocation (minority) provides fuel to obtain additional profitability. Making a gastronomic simile, the Satellite allocation would be the salt that makes the dish ( Core) tastier.
4. Synergy between active and passive management
The combination of a low rotation of the Core allocation and a high rotation of the Satellite allocation allows us to achieve a very interesting investment equilibrium, without suffering the burdens of other more aggressive or short-term strategies, and without falling into tedium. In this way, we manage to mix two totally complementary investment approaches in the same portfolio: passive indexation and active participation.
The magic of the synergy between active and passive management that we just talked about is due to the balance by which this popular investment strategy is governed. The fact that the Core position (actively managed) is much larger than the Satellite position (passively managed) offers a great balance in the results, by limiting the human factor, but without stifling the possibility of beating the market. You decide what percentages you want to apply to your Core-Satellite portfolio. A 70-30 offers the most recommended balance point for all types of investors. Those with the most experience and risk appetite can trade with a 60-40 approach, while the less experienced will be more comfortable with an 80-20 approach.
In conclusion, applying the Core-Satellite strategy when building our investment portfolio can be an excellent option in order to obtain good returns with controlled risks and costs. We are talking about a balanced, versatile investment approach with a real possibility of beating the markets, which takes advantage of all the good of active and passive management. And all this to give the investor the greatest possibilities of profit, to make it more feasible to achieve the dream of beating the markets. So what are you waiting for to build your own Core-Satellite portfolio with all the possibilities that eToro has to offer?