The Core Satellite Investment Strategy Explained

Putting together an investment portfolio that is both as crisis-resistant and as profitable as possible is no easy task. The core-satellite strategy is meant to simplify this task. This moneyland.ch guide explains the logic behind this popular strategy.

What is the core-satellite strategy?

The core-satellite strategy is a widely-used concept for diversifying investments. In this strategy, an investment portfolio is divided into a core and one or more satellites. In the common interpretation, the core makes up around 80 percent of your investments, while the satellite portion makes up around 20 percent. But the size of these two components can vary between portfolios.

The goal: To create a portfolio that best combines minimizing risk with optimizing potential returns, and ideally outperforms the market as a whole. The strategy was first developed by US economists Fischer Black and Jack Treynor in 1973. The core-satellite strategy makes it possible to invest actively without putting all of your eggs in one basket.

What exactly are the core and satellite?

The core is the most important part of your investment portfolio. It should be as broadly diversified as possible, and the risk of loss should be assessable and negligible. Exchange-traded funds (ETFs) that track global indices are one example of the kind of component that would typically be included in the core. Secure bonds are another.

The satellite part of your investment portfolio simply complements the core. It is made up of one or more investments that you choose based on your personal preferences and interests. These components can help to further diversify your portfolio, but they do not necessarily need to be spread over many different assets. The focus with the satellite portion is to complement your well-diversified core with stocks and ETFs that have the potential to bring above-average returns. Examples of possible satellite components include shares in individual companies and ETFs that invest in specific countries and industry sectors. Unlike the core, for which the risk of loss must be minimal, the satellite portion can include more risky components.

Table 1: Overview of the core-satellite strategy

How can I implement this strategy?

If you are interested in using the core-satellite strategy, the first thing you need to do is define the core of your investment portfolio. The core should provide a well-diversified foundation. An ETF based on a global stock market index with numerous components is generally the ideal component for the core.

Choosing components for the satellite portion generally requires some amount of research. Betting on individual countries, industry sectors, or stocks is normally only advisable if you have a good understanding of your investments. Take time to study up on possible investments before you decide which ones to include. In every case, you should not invest in anything that you do not understand. Once your portfolio is up and running, take time to regularly compare the satellite portion with the core, and make changes to it if necessary.

In order to invest in stocks and ETFs, you need to have a stock brokerage account.

Can I use just one ETF for my whole core-strategy portfolio?

No, there is no single ETF that gives you a full core-satellite portfolio (as per May, 2024). But there are some ETFs – such as global ETFs – that can be used as the largest or even the only component in the core. You can choose the components of your satellite portion based on your preferences, interests, and your own investment knowledge.

Could I benefit from using the core-satellite investment strategy?

Using the core-satellite strategy is beneficial for many groups of investors because it combines low risk with high potential returns. The core-satellite strategy is particularly useful for investors who have a very good understanding of one specific industry sector or company, and its potential to generate returns. Using satellite components that you do not really understand is akin to a game of luck. But be aware that losses can never be ruled out, even if you know exactly what you are investing in.

What are the problems with the core-satellite strategy?

While the core that makes up the bulk of your portfolio is made up of a passive, broadly diversified global portfolio, the satellite portion is much like an actively managed portfolio. The goal of the satellite is to outperform the market. That is not a problem per se, but it can bring a number of problems with it:

• Knowledge requirements: Choosing what to invest in on top of the core requires founded knowledge. You should only invest in products, sectors, and companies if you have a good understanding of their business models and potential risks.
• Time and effort requirements: The components of the satellite portion must be reviewed and adjusted regularly, which takes time and effort. You may also have to make ongoing adjustments in order to maintain your chosen core-to-satellite ratio as time passes.
• Higher risk of loss: Having a satellite portion in your investment portfolio normally increases the risk of loss. But the risk is limited because the well-diversified core always makes up the bulk of your portfolio.

For inexperienced investors, using a broadly diversified global portfolio without satellites is a better choice. A purely passive portfolio is also more suitable if you do not have any special interest areas that you want to invest in. Over the long term, the stock market as a whole often delivers higher returns than active investments in individual assets. Using just one diversified component also reduces the administrative and financial costs of putting together your portfolio.

Note: Information provided in this article is for educational purposes only and should not be considered investment advice.

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