Discover the core-satellite: balancing hot trends with risk reduction

Key Takeaways

- "Core" assets are used as the main allocation to pursue long-term returns; "Satellite" assets are supplementary allocations investing in relatively high-elasticity assets.

- Bond ETFs and broad-based index ETFs are mainstream choices for "Core" assets.

- By using ETFs to form your "satellite" assets, you could gain a wide range of choices, save time and effort, and diversify your risk.

Today, let's explore a simple yet potentially effective investment strategy: the core-satellite approach. Originating in the 1990s and popularized by financial powerhouses like Vanguard and Barclays, this strategy is designed to balance risk and reward while giving you the freedom to invest in your favorite hot stocks.

What is the "core-satellite" strategy?

Let’s dive into an example to see the core-satellite strategy in action.

Suppose a U.S. investor aims to build a low-risk portfolio with steady long-term growth. At the same time, they are bullish on explosive opportunities in sectors like AI, robotics, and cryptocurrencies. Here’s how they might structure their portfolio:

1. Core Investment (80%): Allocate 80% of the portfolio to a U.S. all-bond market ETF for low-risk, long-term growth.

2. Satellite Investments (20%): Allocate 5% each to:

   a. Nvidia (AI and GPUs)

   b. Microsoft (technology and cloud computing)

   c. Tesla (electric vehicles and robotics)

   d. A cryptocurrency-related product

In this scenario, the investor has effectively adopted the Core-Satellite strategy, with the 80% bond ETF serving as the "core" and the remaining 20% in individual stocks and cryptocurrency-related products as the "satellites."

You might wonder, can you choose different core and satellite assets? Absolutely! Next, we'll explore how to customize your own core-satellite portfolio to suit your unique investment preferences.

How to build a core-satellite portfolio

Investors are free to choose "core" and "satellite" assets as long as they meet the following definitions: "Core" assets are used as the main allocation to pursue stable and sustainable long-term returns; "Satellite" assets are supplementary allocations investing in relatively high-risk, high-elasticity assets.

Let's take a closer look at each category.

"Core" assets

Core assets in a portfolio can be categorized based on their risk level: conservative or moderate.

Conservative core assets are primarily fixed-income assets, known for their very low risk but also lower yields.

On moomoo, you can find a list of bond ETFs by clicking Markets > ETFs > Heat Map > Bonds. Click on a specific ETF to view key information about that ETF, such as dividend yield and payout history.

Moderate core assets primarily consist of broad-based index ETFs. These ETFs track major market indices and offer a balanced approach to risk and return. Over the past five years, as reported by S&P Indices Versus Active (SPIVA), a staggering 78.68% of equity funds in the United States have failed to match the performance of the S&P 500 index.

On moomoo, you can find broad-based index ETFs by clicking Markets > ETFs > Index ETFs. Click on a specific ETF to view key information about that ETF, such as the index its tracks and its management fee.

It's possible to diversify by pairing multiple core assets rather than choosing just one. In addition to fixed-income ETFs and broad-based index ETFs, there are real estate ETFs, commodity ETFs, and foreign index ETFs which could be included in your portfolio.

For example, a diversified core portfolio might include:

- 30% fixed-income ETFs

- 30% broad-based index ETFs

- 10% real estate ETFs

- 10% gold ETFs

These allocations together would make up 80% of your core asset holdings.

On moomoo, you can explore a wide range of ETFs by navigating to Markets > ETFs > Heat Map.

"Satellite" assets

For satellite assets, there are many options, with some mainstream choices being:

- Hot stocks (e.g. NVIDIA, Microsoft)

- Thematic sectors such as AI and robotics

- Alternative assets like Bitcoin

The key to investing in satellite assets is flexible allocation and dynamic adjustment. By using ETFs for these investments, you could gain a wide range of choices, save time and effort in analysis and tracking, and diversify your risk to some extent.

On moomoo, you can find ETFs investing in these assets by navigating to Markets > ETFs.

Are you wondering if the strategy actually works? Let's build a mock portfolio and perform a data backtest.

Case study

Simulated portfolio overview

1. Testing Period: Conduct backtesting from April 30, 2021, to April 29, 2024, over three years.

2. Markets Covered: The portfolio includes mainstream U.S.-listed ETFs.

3. Rebalancing: Assume a static allocation with no rebalancing during the three-year period.

4. Benchmark: S&P 500 Index

5. Core Assets: Allocate 60% to an S&P 500 index ETF.

6. Satellite Assets: Diversify 10% each into a gold ETF, a REIT ETF, a crude oil ETF, and an autonomous driving ETF.

Backtesting results

Backtesting analysis

Our analysis indicates that the simulated core-satellite portfolio has delivered higher returns with lower volatility and reduced maximum drawdown compared to the S&P 500 index. The strategy also boasts a higher Sharpe Ratio, suggesting a more favorable risk-adjusted return.

Summary

In short, core-satellite strategy is a flexible and practical strategy. Using ETFs as core or satellite assets not only offers a wide range of choices but also saves time and effort.

Investors should first set the ratio of core and satellite assets according to their risk appetite. For example, 90%/10% for a conservative investor or 60%/40% for a risk-seeking investor.

Next, investors should form their "core" assets using bond ETFs, broad-based index ETFs, real estate ETFs, commodity ETFs, foreign broad index ETFs, etc., with flexible proportions for each type of product.

Finally, investors should form their "satellite" assets with highly resilient underlying products such as hot stocks, thematic ETFs, and Bitcoin ETFs.

Would you like to give this strategy a go? Open moomoo to find and manage your core and satellite assets!