Opinion
How a 'core satellite' investment strategy can work for you
A "core satellite" approach to investing is used by many large institutions, including Australia's sovereign wealth Future Fund, as well as a host of "mum and dad" investors.
If it is something not already in your investment toolkit, your portfolio may not be performing as well as it could.
Your core stock holdings are like the sun and all the planets are your satellite, smaller investments.Credit:
A "core satellite" strategy involves having the bulk of your investments in stable, lower-risk holdings – the core – and then have several smaller, higher risk (and potentially higher reward) investments to complement these holdings – the satellites.
Think of it like a diagram of the solar system. Your core is the sun and all the planets are your satellites. The sun is many magnitudes larger than any of the planets spinning around it. So, too, your core holdings should make up the bulk of your investment portfolio, whilst your satellites are a series of smaller stock plays, aiming to boost your returns at the margins.
The goal with this strategy is that none of the investments in the satellites are big enough that, if things go badly with any of them, they will seriously hurt the overall value of your portfolio.
"Core satellite" portfolio construction is a risk-management strategy. It helps you obtain reliable outcomes and that should be a key investment objective.
The strategy could also help smooth out returns, depending on the satellites you choose. If some are negatively correlated to your core holdings when markets turn down, the satellites might provide some positive performances to help counter the fall in value of the portfolio as a whole.
There are several ways you can implement a "core satellite" strategy.
Most commonly, for the core, you could buy several broad Exchange Traded Funds (ETFs) or managed funds. For example, one covering the benchmark S&P/ASX 200 Index in Australia or the S&P 500 Index in the United States.
Your core might even contain more conservative investments, such a bonds, depending on your investment time-frame or appetite for risk.
It is with the satellite investments that things can really vary.
Your satellites could be individual stocks. These could be small or mid-cap companies, given you have many of the large-cap stocks already covered in your core holdings.
Your hope is that one or two of these smaller holdings might prove to be the next Tesla or Amazon. You accept that most will probably perform nowhere near those levels and the odd one might crash and burn. That is okay, though, because each of these satellites is so small.
Another way is to use ETFs as your satellites. Sector-specific ETFs are popular, with options including healthcare, renewable energy, technology, agriculture, property or even currencies.
There are also geographic options, such as Asian shares, or an even a narrower focus on a specific countries if you hold a strong view on their outlook.
Our relatively small local sharemarket presents diversification challenges. Sector-specific satellites could enable you to get greater exposure to those industries, boosting the potential for higher growth, resiliency or both.
Paul Benson is a financial planner and host of the Financial Autonomy podcast.