Are Your Core and Satellites Working in Harmony?

Here’s a question you won’t be asked everyday: are your core and satellites working in harmony?

This question doesn’t relate to your gym workout plan. The core-satellite approach is a portfolio construction strategy which is gaining renewed attention amongst some investors. And for good reason. Blending stability with flexibility, this strategy offers a structured yet dynamic way to optimise returns while effectively managing risk…

What is Core-Satellite Investing?

Core-satellite investing is a portfolio construction strategy that divides a portfolio into two separate components:

1. Core: A diversified, low-cost foundational portfolio designed to deliver long-term, market-like returns. Think of the core as the investment engine: the steady, reliable portion which is built to go the distance.
2. The Satellites: A set of more specialised, actively managed or tactical investments intended to enhance performance or manage specific risks. The satellites are performance boosters. They tend to be targeted and more opportunistic, enabling you to take advantage of market trends, thematic plays, or inefficiencies.

How it Helps Investors

The core-satellite approach is well-suited to address many of the challenges faced by investors.

For example, the benefits include:

• Cost Efficiency: By anchoring your portfolio with low-cost ETFs, investors are able to keep fees down which allows their returns to better compound.
• Diversification: The core provides broad market exposure, while the satellites enable targeted bets on sectors, regions, or styles not captured in the core. All up, a core- satellite portfolio benefits from enhanced diversification.
• Risk Management: The satellites can be used to hedge specific risks such as inflation and currency, while they can also be help address home market bias.
• Return Enhancement: Actively managed satellites can add alpha to a core which is performing in line with the market.

Constructing the Core

The core should represent the majority of your portfolio, usually 60–80%, depending on your risk profile and investment horizon. For most investors, it is built using passive or rules-based strategies. These might include:

• ASX 200 ETFs: Such as Global X S&P/ASX 200 High Dividend ETF (ASX: ZYAU), to capture Australian equity exposure.
• Global Equity Index Funds: Such as JPMorgan Global Research Enhanced Index Equity Active ETF (Managed Fund) (Hedged) (ASX: JRHG), for global diversification.
• Fixed Income ETFs: Such as JPMorgan Global Bond Active ETF (Managed Fund) (Cboe: JPGB), for global bond exposure.
• Real Assets Exposure: Such as JPMorgan Sustainable Infrastructure Active ETF (Managed Fund) (ASX: JPSI), for defensive infrastructure exposure.

The key attributes of a successful core are broad diversification, low cost, and transparency.

Designing the Satellites

Satellites allow investors to express their specific views, seize emerging opportunities, or manage nuanced risks. The satellite portion might consist of 20–40% of the portfolio and include:

• Managed Funds: Such as Trillium ESG Global Equity Fund with a proven ability to outperform in niche areas such as small caps, emerging markets, or ESG strategies.
• Thematic ETFs: Such as Investible Climate Tech Fund with a focus on structural investment themes like AI, clean energy, or biotech so as to gain tactical exposure to sectors with strong tailwinds.
• Alternatives: Add private equity such as iPartners Emerging Equity Fund, hedge funds, or commodities to enhance diversification and reduce correlation with traditional assets.
• Tactical Tilts: Add short-to-medium-term positions based on your macroeconomic views. e.g. An overweight defensives position such as Healthbridge Capital in a late-cycle environment may be prudent, as may rotating into inflation hedges when inflation is trending upwards.

Practical Considerations

Here are a few practical considerations to bear in mind with core-satellite portfolio construction:

1. Rebalancing

   Establish clear rules for rebalancing the portfolio back to your target allocations. This might be done quarterly, semi-annually, or based on tolerance bands. Rebalancing enforces discipline, and keeps risk in check.

2. Costs and Taxation

   Use tax-aware structures where possible, such as ETFs with low turnover or managed accounts that allow capital gains deferral.

   Be mindful of franking credits, which can make Australian equities more attractive in taxable accounts, and consider holding international assets in tax-efficient vehicles within superannuation.

3. Behavioural Discipline

   The core-satellite structure helps counteract many common behavioural pitfalls. For example, by anchoring their portfolio with a core that performs steadily over time, investors may feel less pressure to overtrade or chase short-term performance.

4. ESG and Impact Considerations

   Many investors integrate environmental, social, and governance (ESG) criteria into their portfolios to great effect.

   The core-satellite framework enables this elegantly: by maintaining broad exposure through sustainable ETFs such as JP Morgan Climate Change Solutions Active ETF (Managed Fund) (ASX: T3MP), and targeting impact investments such as NorthStar Impact Australian Equities Fund within their satellite allocations.

A Real-World Example

Consider an Australian investor, Sarah, aged 45 with a balanced risk profile and a $1 million portfolio.

Her core might consist of:

• 25% in Australian Equity ETFs such as Betashares Australian Dividend Harvester Fund (managed fund).
• 25% in Global Equity ETFs such as Betashares Diversified All Growth ETF (ASX: DHHF).
• 15% in Australian Bond ETFs such as Betashares Australian Bank Senior Floating Rate Bond ETF.
• 10% in Global Bond ETFs such as JPMorgan Global Bond Active ETF (Managed Fund) (Cboe: JPGB).

Her remaining 20% could be invested in satellites such as:

• 5% in actively managed Australian small-cap funds such as Seneca Australian Small Companies Fund.
• 5% in a thematic managed fund focusing on climate innovation such as TT Global Environmental Impact Fund.
• 5% in a private equity fund such as HMC Capital Partners Fund 1.
• 5% tactical position in a gold ETF such as Global X Physical Gold Structured (ASX: GOLD).

This diversified mix allows Sarah to participate in broad market growth, benefit from the cost efficiency of ETFs, and still express her investment views without constantly reshuffling her portfolio.

More Than Financial Theory

Core-satellite investing is not just a theoretical approach to portfolio construction. It’s a practical and proven way to navigate complexity while enabling investors to achieve their long-term goals. It offers a compelling blend of structure and flexibility, enabling investors to maintain a disciplined long-term strategy while remaining agile.

Like the best gym workout plans, the devil is in the details. Asset selection, cost control, tax awareness, and behavioural discipline will ultimately shape your outcomes. But executed thoughtfully, core-satellite portfolio construction can be a powerful engine for generating optimised, risk-adjusted returns.

Disclaimer: This article is prepared by Simon Turner. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.