Building a core-satellite investment portfolio
Endowus Insights

Building a core-satellite investment portfolio

Updated
8
Sep 2022
published
8
Aug 2022
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investment portfolio construction - strategic vs tactical investing

Strategic asset allocation is a long-term strategy whereby you decide how to divide your investment portfolio among different asset classes — mainly stocks, bonds, and cash — based on your risk tolerance, time horizon, and financial goals.

You start by setting the target weights or proportions for each asset class.

After that, you periodically adjust the current portfolio allocations to rebalance them back to the original targets. These weights will tend to deviate from your targets over time, due to the assets’ differing performance. The rebalancing is usually done at regular intervals, such as annually. 

The aim is to balance risks and returns through a diversified investment portfolio in the long run, to attain your financial goals.

Strategic asset allocation

Here’s an example to illustrate how strategic asset allocation works. 

Jane is 30 years old and has a moderate risk tolerance. A year ago, she invested $200,000, split into 50% equities, 30% bonds, 15% commodities, and 5% cash. That worked out to target allocations of $100,000 for stocks, $60,000 for bonds, $30,000 for commodities, and $10,000 for cash.

The table below shows her target allocations as well as the assets’ current market values a year after she made these investments, based on their respective annual returns.

Asset class Target allocation (%) Target allocation ($) Annual returns Current allocation after 1 year
Equities 50% $100,000 12% $112,000
Bonds 30% $60,000 2.5% $61,500
Commodities 15% $30,000 5% $31,500
Cash 5% $10,000 0.5% $10,050
Total 100% $200,000 - $215,050

Her portfolio value has grown to $215,050 after one year. It is now made up of 52.1% equities, 28.6% bonds, 14.6% commodities, and 4.7% cash. These weights deviate from Jane’s target proportions.

Under the strategic asset allocation approach, she therefore readjusts the investments in each category back to the original targets, as shown in the following table. For instance, to make sure equities make up half of the latest $215,050 portfolio, she sells $4,475 worth of shares. Using those sales proceeds, she buys more bonds and commodities while putting more cash into the portfolio.

Asset class Current allocation after 1 year ($) Current allocation after 1 year (%) Target allocation New allocation Adjustment
Equities $112,000 52.1% 50% $107,525 -$4,475
Bonds $61,500 28.6% 30% $64,515 +$3,015
Commodities $31,500 14.6% 15% $32,258 +$758
Cash $10,050 4.7% 5% $10,753 +$703
Total $215,050 100% 100% $215,050 $0

After the rebalancing, her portfolio is back to 50% equities, 30% bonds, 15% commodities, and 5% cash.

This is considered a passive investment strategy, as it does not require frequent changes to the portfolio in response to short-term market fluctuations. Learn more about Endowus' Strategic Passive Asset Allocation here.

What is tactical allocation?

In contrast, the tactical asset allocation strategy is an active investing approach. It involves more frequent trading and a shorter-term view.

Tactical investors modify their portfolio’s allocations based on the latest market conditions, which may change often. The goal is to maximise short-term profits and portfolio returns.

By actively shifting the proportions of their investments, they hope to take advantage of prevailing or expected market trends, economic conditions, or perceived mispricing opportunities.

Staying with the earlier example, let’s say that after the first year of her investment journey, Jane believes she now has enough expertise, interest, and time for tactical asset allocation, and stops using the strategic approach.

She expects a recession to happen soon, considering the current macroeconomic situation and growing inflationary pressures. As a tactical investor, she decides to shift away from equities and into lower-risk and potentially inflation-hedging assets such as bonds and commodities. She keeps the cash allocation at 5%.

When Jane rebalances her $215,050 portfolio, she cuts the weighting of equities to 40%, from 50% previously. The proportion of bonds is increased to 35%, from her original target of 30%. And she allocates 20% to commodities, up from 5% under the strategic approach.

Asset class Current allocation after 1 year New allocation (%) New allocation ($) Adjustment
Equities $112,000 40% $86,020 -$25,980
Bonds $61,500 35% $75,268 +$13,768
Commodities $31,500 20% $43,010 +$11,510
Cash $10,050 5% $10,753 +$703
Total $215,050 100% $215,050 $0

If she sticks with tactical asset allocation, Jane will likely adjust her portfolio again when the global economy recovers. This may involve buying more shares so she can become more aggressive with regards to equities.

Set a core-satellite investing strategy

A core-satellite investment strategy is a method to construct your portfolio, with two components. 

The core assets make up the largest portion of your portfolio. This is then complemented by smaller holdings, as the satellite portion.

The core component tends to represent your strategic asset allocation and can be managed passively. It may include a large-cap stock index fund that provides exposure to a wide variety of industries, sectors, and geographies, for instance. Another possibility for your core holding could be a 60/40 mix of equities and government bonds. 

The satellite investments may give you a more concentrated or narrower exposure, for example in a single country, a specific sector, or a theme (such as clean energy).

The objective of this portfolio design is to reduce risk through diversification and to outperform a broad market benchmark such as the S&P 500 index

Core-satellite investing can offer the best of both worlds. The core component may use a strategic allocation approach to churn out consistent returns at low costs over the long run, while the satellite holdings give investors the flexibility to supplement their portfolio with tactical short-term opportunities to enhance returns. 

The core-satellite concept is a prudent way to manage your total portfolio for long-term results. It is favoured by institutional investors as well as individual investors who plan to stay invested in the long run.

Find out why our Flagship Portfolios should make up the core of your investment portfolio, and learn more about our Satellite Portfolios. To start your investment journey, click here.

Next on the Endowus Fin.Lit Academy

Read the next article in the curriculum: How you can approach core and satellite investing with Endowus

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Investment involves risk. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested. Past performance is not an indicator nor a guarantee of future performance. Rates of exchange may cause the value of investments to go up or down. Individual stock performance does not represent the return of a fund. 

Any forward-looking statements, prediction, projection or forecast on the economy, stock market, bond market or economic trends of the markets contained in this material are subject to market influences and contingent upon matters outside the control of Endow.us Pte. Ltd (“Endowus”) and therefore may not be realised in the future. Further, any opinion or estimate is made on a general basis and subject to change without notice. In presenting the information above, none of Endowus Pte. Ltd., its affiliates, directors, employees, representatives or agents have given any consideration to, nor have made any investigation of the objective, financial situation or particular need of any user, reader, any specific person or group of persons. Therefore, no representation is made as to the completeness and adequacy of the information to make an informed decision. You should carefully consider (i) whether any investment views and products/ services are appropriate in view of your investment experience, objectives, financial resources and relevant circumstances. You may also wish to seek financial advice through a financial advisor or the Endowus platform and independent legal, accounting, regulatory or tax advice, as appropriate.

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