How to invest using ETFs: enhanced core-satellite portfolio construction

How to invest using ETFs: enhanced core-satellite portfolio construction

This article was brought to you by our friends over at ETF Securities Australia. The views and opinions expressed in this article are those of ETF Securities Australia and may not reflect the views of SelfWealth or its associates.

Before investing in any ETFs, you should consult the respective product’s Product Disclosure Statement, which will be available on the fund’s website.

Knowledge level: Intermediate  Reading time: 7-9 minutes

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Whatever your financial goals are, many investors may be considering how best to build their investment portfolio. One option to consider is ‘enhanced core-satellite investing’ using ETFs, which is a flexible and cost-effective approach that can be helpful in times of market volatility.

 

What is enhanced core-satellite investing?

Enhanced core-satellite investing is a two-pronged approach to portfolio construction.

The ‘core’ of the portfolio is made up of passive exposures to major asset classes, mainly equities and fixed income. Meanwhile, ‘satellite’ investments are more opportunistic and designed to seek specific growth outcomes, sometimes at higher levels of risk.

One view is that the enhanced core might comprise 65-85% of the portfolio, depending on the investor’s goals, investment horizon and risk tolerance, while satellites tend to represent 15-35% of the portfolio.

 

 

How is enhanced core-satellite investing implemented?

Investors should consider the enhanced core as where they implement their strategic asset allocation. That is, where the long-term targets are set for the investment composition to meet your goals, needs and views. By contrast, the satellite is for tactical asset allocation, for shorter-term investments based on market and world conditions that are likely to be more temporary in nature.

Traditionally, core passive exposures may have been broad-based, such as the entire S&P/ASX 300 or S&P 500. Today, however, investors are more likely to look for tailored options.

Tailored options include exposure which may specifically identify or exclude companies based on criteria like quality and yield, or allocating a different weight towards index assets to offer varying performance to the market. One example of this might be using an ETF which identifies a limited number of companies from the S&P/ASX 300 based on quality and yield criteria as exposure to Australian equities.

Satellite investments can be investments in individual companies, real estate, targeted ETFs or actively-managed funds. How this might look in practice is as follows. An investor with a goal for high growth in the long-term and higher risk tolerance may wish to use the satellite component of their portfolio to create a ’tilt’ towards riskier and higher-growth areas —for example, growth in artificial intelligence and automation, or emerging market growth.

Alternatively, an investor focused on income might use the satellite components for yield, or proactively switch to defensive or growth tilts to bolster their core investments depending on market conditions. For example, adding increased allocations to commodities like gold, which may offer a buffer in volatile markets.

 

What makes an investment a core or satellite exposure?

Enhanced core-satellite investing is a flexible approach, so a core investment for one person might be a satellite investment for another person. It’s all down to individual goals, needs, circumstances and situation.

An investor with a high-growth strategy might have a core with a higher proportion of ‘riskier’ assets like equities, while a defensive strategy might focus more on assets like gold or fixed income.

 

 

Managing investment costs

An enhanced core-satellite approach can assist with cost management for investors, depending on the investments you choose.

The core uses passive exposures, which are typically lower cost when compared to actively managed funds. Using ETFs may offer additional pricing efficiencies for investors such as lower administration and management fees, as well as a lower entry point compared to managed funds and listed investment trusts.

For example, in the top-performing funds assessed under the Canstar Star Ratings, management fees for managed funds ranged from 0.19% up to 2.5%, with many including separate administration fees of up to 0.15% and performance fees up to 35%.

By contrast, management costs for ETFs generally range from less than 0.1% to 1%, with those at the higher-end typically associated with more complex asset classes, difficult-to-access asset classes, or with more significant tailoring as far as rules criteria.

Depending on the assets held in the benchmark index, ETFs also tend to be highly liquid, allowing investors to free-up funds as needed for cash needs or to access other satellite opportunities in a relatively cost-effective way.

When considering the effect of fees on returns over the long-term, as well as allowing for the ability to adapt a portfolio to unexpected changes in circumstances, aiming for the bulk of a portfolio to be flexible and lower-cost can be practical for many investors.

Furthermore, investors can also consider how they allocate their ‘fee budget’. That is, how much they want to pay across their portfolio in fees, with some investors considering a higher budget for satellite investments where they think there may be opportunities for outperformance.

 

 

Finding the right investments for the strategy

Selecting the way you construct your portfolio is only the beginning. The next step is identifying what investments can help you reach your goals, with the ASX being a good starting point.

The good news for investors looking at ETFs is that the continued growth of the market means it is becoming easier than ever to find tailored options to suit an enhanced core or satellite needs, or even express moral and ethical sentiments. At the end of the day, there’s no reason why your investment portfolio shouldn’t be personally suited to your needs and views.

 

For more information on enhanced core-satellite portfolio construction or to find out more about using ETF Securities Australia’s range of ETFs in your portfolio, you can speak to ETF Securities Australia directly using the details below.

 

To invest in ASX-listed ETFs or any other ASX-listed securities, join SelfWealth today for flat-fee $9.50 brokerage and no other account fees or commissions!

 

ETF Securities Australia Client Services

Phone +61 2 8311 3488

Email: infoAU@etfsecurities.com.au

 

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General Advice Warning

This document is communicated by ETFS Management (AUS) Limited (Australian Financial Services Licence Number 466778) (“ETFS”) for publication by SelfWealth Ltd ACN 52 154 324 428 (“SelfWealth”) (Australian Financial Services Licence Number 421789). This document may not be reproduced, distributed or published by any recipient for any purpose. Under no circumstances is this document to be used or considered as an offer to sell, or a solicitation of an offer to buy, any securities, investments or other financial instruments and any investments should only be made on the basis of the relevant product disclosure statement which should be considered by any potential investor including any risks identified therein.

This document does not take into account your personal needs and financial circumstances. You should seek independent financial, legal, tax and other relevant advice having regard to your particular circumstances. Although we use reasonable efforts to obtain reliable, comprehensive information, we make no representation and give no warranty that it is accurate or complete.

Investments in any product issued by ETFS are subject to investment risk, including possible delays in repayment and loss of income and principal invested. Neither ETFS, ETFS Capital Limited nor any other member of the ETFS Capital Group guarantees the performance of any products issued by ETFS or the repayment of capital or any particular rate of return therefrom.

The value or return of an investment will fluctuate and investor may lose some or all of their investment. Past performance is not an indication of future performance.

Information current as at 21 July 2020.

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