5 rules for building a robust satellite portfolio

In this second part, we follow it up with five more rules for building a satellite portfolio allocation with ETFs.
Hans Lee

Betashares

In part one of this series, we looked at five rules for building a core portfolio allocation. In this second part, we follow it up with three more rules for building a satellite portfolio allocation with ETFs. By the end of this series, we hope you’ll have a basic understanding of how to build a great portfolio that will both thrive in a range of market scenarios and help you achieve your financial goals.

A quick refresher

Core exposures are your building blocks. These are investments that span a range of asset classes that you’ll ideally hold for the long-term. Think of these as the foundation you’ll rarely, if ever, move.

In contrast, satellite exposures are designed to offer access to more opportunistic, thematic or tactical opportunities. Think of these as the secret spices that can help your portfolio beat the market or serve as value-adds. How much you want to allocate toward core investments versus satellite investments is up to you.

Rule 1: Work out what you want your satellite allocation to achieve

This rule comes back to your initial investing goals. For instance, if you want to save for a house deposit and you have under 10 years to do it, then you may want your satellite allocation to be high growth oriented. Alternatively, if you’re investing to accentuate your impending retirement and you don’t want to blow the inheritance, you will probably lean toward defensive options.

Whatever your approach is, you’ll need to consider that this portion of the portfolio has higher risks but may provide higher rewards. The other thing to note is that satellite allocations, unlike their core counterparts, are not set and forget. Therefore, the investments you decide on should be monitored with regular frequency.

Rule 2: Keep your balance in check

While long-term investing is the best way to compound your wealth and reach your financial goals in a timely fashion, it’s important to ensure your balance does not stray too far from your original plan. The pros call this an “exposure limit” or a “portfolio rule”1.

For instance, you may realise that although you’ve decided to allocate 30% of your portfolio to global equities, you’d be uncomfortable if this figure ever breached 40% (implying the value of your global equity exposure has gone up) or 20% (implying the value of your global equity exposure has gone down). If either of these barriers were breached, you should create a plan to deal with this overweight/underweight accordingly.

Another example applies if you have an individual satellite investment which makes up, for example, a 5% weighting in your portfolio. If this satellite investment ever became 10% of your portfolio, would you feel comfortable? If not, you may want to have a plan in place for lightening this investment. Alternatively, if this investment were ever to reach zero, at least you will have made this decision knowing that you’ve only lost 5% (as opposed to a much larger percentage).

Above all, you should be reviewing your investment strategy regularly and undertaking rebalancing as appropriate. The value of holdings will change over time. So, you need to make sure that your portfolio still reflects your risk tolerance2.

Rule 3: What kind of investment do you want?

There are many kinds of satellite investments you could likely make. Deciding which one is for you can depend on a range of factors including your risk tolerance, the cost of the fund, your understanding of the macro theme behind each investment, and perhaps, even your own beliefs. Here are a few examples:

  • Cyclical investments, as the name suggests, will see demand for their products fluctuate based on demand. Cyclical investments are popular choices when the economy is growing3. An example of a cyclical ETF would be the Betashares Global Energy Companies Currency Hedged ETF (ASX: FUEL).
  • Defensive investments are not as reliant on the economic cycle and are often called upon when the economy goes into a downturn. Defensive investments are also popular with investors who have a low risk profile and want stable investment choices. An example of a defensive investment is the Betashares Australian Investment Grade Corporate Bond ETF (ASX: CRED).
  • More recently, a third kind of satellite investment has caught investors’ attention – megatrends. Megatrends include things like artificial intelligence, the changing climate, and resource scarcity. Traditionally a domain of institutional investors who have the horizon and risk profile to make such investments, retail investors have become increasingly interested in megatrends over the last few years. Examples of megatrend ETFs, which are also popular satellite allocations, are the Global Cybersecurity ETF (ASX: HACK) and the Crypto Innovators ETF (ASX: CRYP).
  • Finally, satellite investments are not just broken down by sector. They can also be separated into regions to gain specific exposure to a country’s macro or corporate story. For instance, if you believe the defence thematic has further to run, you can look at the Global Defence ETF (ASX: ARMR).

Rule 4: Right size your investments

Just like your core investments, your satellite investments should also be diversified. In other words, it would not be wise to put all your satellite investment exposures into the latest fad or into a high-growth product that could crash and burn quickly.

For instance, you can achieve an income-oriented satellite allocation by including exposures to both royalty-producing companies (Global Royalties ETF - ASX: ROYL) and bank hybrids (Australian Hybrids Active ETF - ASX: HBRD). Or if you are a believer in the global technology story, it may be wise to have exposures to both the Nasdaq 100 (Nasdaq 100 ETF - ASX: NDQ) as well as non-US tech through products like the Asia Technology Tigers ETF (ASX: ASIA).

If you do decide to take on high-risk/high-reward satellite investments, then make sure you are monitoring your investments closely. For example, while geared ETFs are a way to boost your wealth quickly, you need to be aware that gearing goes both ways. If the market falls, leveraged investments can be expected to produce magnified losses and vice versa.

Those considering cryptocurrency exposure need to know that it is an extremely volatile asset class and prospective investors should have a very small portfolio allocation to it.

Rule 5: The most important rule – do your homework

Before you invest in anything, make sure you do your homework.

  • If you don’t know something, read about it and don’t invest in it until you are sure you understand what you’re getting into.
  • Complete a thorough check to make sure what you’re investing in is legitimate.
  • And finally, only invest what you can afford to lose.

In the final part of this series, we’ll put together a hypothetical portfolio which applies many of these themes into practice.

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Investing involves risk. The value of an investment and income distributions can go down as well as up. An investment in a Betashares Fund should only be considered as a part of a broader portfolio, taking into account your particular circumstances, including your tolerance for risk. For more information on risks and other features of each Betashares Fund, please see the Product Disclosure Statement and Target Market Determination, both available on this website. An investment in CRYP should be considered very high risk. CRYP provides focused exposure to companies involved in servicing crypto-asset markets or which have material investments in crypto-assets. Crypto-assets are highly speculative in nature and companies with significant exposure to crypto-asset markets can be expected to have a very high level of return volatility. An investment in CRYP should only be made by investors who fully understand the features and risks of such companies or after consulting a professional financial adviser, and who have a very high tolerance for risk and the capacity to absorb a rapid loss of some of their investment. CRYP will not invest in crypto assets directly, and will not track price movements of any crypto assets. For more information on risks and other features of CRYP, please see the Target Market Determination (TMD) and Product Disclosure Statement, available at www.betashares.com.au. Sources: 1. https://www.livewiremarkets.com/wires/did-the-tech-selloff-hurt-more-than-it-should-here-are-6-tips-to-avoid-the-pain-next-time ↑ 2. https://www.linkedin.com/pulse/core-satellite-investment-strategy-timothy-clifford-/ ↑ 3. https://www.investopedia.com/articles/02/102202.asp ↑

Hans Lee
Senior Finance Writer
Betashares

Hans is the Senior Finance Writer at Betashares. He is best known to Livewire audiences as the former moderator of 'Signal or Noise' as well as a Senior Editor. He has a double degree in economics and journalism.

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