1. In today’s volatile markets, some investors may want to look beyond traditional investing strategies.
They might consider designing a portfolio with potential to outperform market indices over the
long term while taking advantage of short-term market opportunities that could help dampen the
impact of market fluctuations. An effective way to achieve this is by constructing what’s known as a
The “core” helps investors withstand volatility because these tend to be long-term investments
spread across a range of stocks and bonds, says Mike Loewengart, Director of Investment Strategy
for E*TRADE. The “satellite” positions may be more actively traded, allowing investors to target
investments they think are ready to grow and that can help diversify the portfolio, as well as poten-
tially offset negative stock and bond returns.
How It Works
Core and satellite portfolio construction divides your investment portfolio into two parts. The core
portion of the portfolio — which typically ranges from 60% to 90% of total assets — is held in low-
cost equity and bond investments, such as broad stock and bond mutual funds, ETFs, index funds
or “balanced” funds/ETFs that contain a prescribed mix of stocks and bonds that can be selected
to fit the investor’s need. The overall asset allocation within the core holdings should align with your
personal investing objectives and time horizon. Also, because one of the goals of this strategy is
to minimize costs, Loewengart recommends investing in mutual funds or ETFs with expense ratios
of less than 1%.
For example, investors seeking an allocation target of 60% equities and 40% fixed income might
spread their core position among a few funds or ETFs that give them exposure to a broad range of
domestic and international stocks and bonds. Or they might choose to invest in just one low-cost
balanced fund or ETF that typically keeps 60% in equities and 40% in fixed income.
The satellite portion — usually 10% to 40% of the total portfolio — is used to achieve two goals:
First, investors can pursue greater long-term returns by adding or overweighting specific sectors,
subsectors or individual stocks that they anticipate will outperform the investments in the core por-
tion over the short term. At the same time, these investments can be used to build a hedge against
market volatility by incorporating asset classes that have lower correlations with those in the core
group, meaning they are likely to perform somewhat differently under the same market conditions.
Commodities, for instance, tend to have a low or negative correlation with traditional assets like
stocks and bonds because they respond differently to economic cycles.
The satellite portion of the portfolio could, for instance, be spread across various asset classes that
the investor wants to overweigh, such as emerging markets, growth and small-cap equity funds. It
could also include alternative assets, such as real estate or commodities, or even individual stocks
that the investor believes are well positioned for growth.
Core and Satellite Investing
E*TRADE Capital Management
Core and Satellite Investing: Cost Efficiency with Potential for
2. A Customized Approach
How investors divide their portfolio between core and satellite will depend on their risk tolerance
and how much of a hands-on role they want to play in maintaining their portfolio. An investor seek-
ing a less-involved role may want to keep a higher allocation in his or her core portfolio, Loewen-
gart says. That’s because building and monitoring the satellite portion often requires more analysis
and more regular oversight, which may involve a lot of additional time.
The core holdings generally are meant to be purchased for the long term and thus only need oc-
casional rebalancing to maintain their target asset allocation. The satellite holdings will need closer
monitoring and maintenance, he says, because they may be more volatile and grow or decline
more quickly in comparison to the core holdings. So investors may need to trim back satellite posi-
tions that have outgrown their asset allocation target or to make changes to them based on per-
ceived market opportunities. While the ratios between core and satellite can vary among investors,
your core holdings should comprise the bulk of the portfolio, Loewengart says.
Find a Benchmark to Track Returns
Since you are using two different investment strategies within your portfolio, it’s important to estab-
lish a benchmark against which you can measure your overall performance, advises Christine Benz,
Director of Personal Finance for Morningstar.com. That benchmark could be a market index, such
as the S&P 500, that allows you to compare whether your core-satellite portfolio is indeed outper-
forming the broader equity markets.
The chart below shows historic correlations (1997 – 2012) between the S&P 500 Index and other
types of market indices, including domestic and international stocks, specific stock sectors, bonds,
commodities and REITs. The lower the ratio listed on the matrix, the less that index performed
similarly to the S&P 500 for that particular year. A negative ratio means the index moved in opposite
directions from the S&P. Investors can use this information to help select funds and ETFs for their
satellite positions that have lower or negative correlations with their core positions. For example,
someone with a core position that tends to closely echo the performance of the S&P 500 index may
want to look at whether adding precious metal investments or commodities to their satellite posi-
tions makes sense. Both of these sectors in the matrix show very low correlations over the years.
(For details, see the chart.)
Correlation Matrix: Returns vs. S&P 500
July 1997 - June 2012
Core and Satellite Investing
SOURCE: Zephyr StyleADVISOR
3. Investors will also want to periodically check their satellite investments to see if they are fulfilling
their purpose and outperforming the core portfolio over a longer time frame of at least a year. “The
challenge with the satellite piece is making sure that you’re adding value,” Benz says.
Done right, however, a core-and-satellite strategy may deliver an investing trifecta: market-beating
performance, lower volatility and lower investment costs in one flexible portfolio tailored to meet
your specific needs.
Core and Satellite Investing