The Core Satellite Portfolio

Today I’m going to introduce you all to my style of investing. If you’ve been following me for some time, it may seem like I am strictly a dividend investor. However, it just so happens that the stocks I own have dividends. Using the teachings of Benjamin Graham and Warren Buffett, if you have to hold stocks for a long time before it realizes its potential, you’ll at least be paid a dividend in the meantime. Therefore, that’s why my portfolio contains dividend stocks. Additionally, my portfolio follows a unique structure, which I will explain, called the Core Satellite Portfolio.

Before explaining it, let’s paint some background.

Investors tend to fall into two types of categories: passive, active. The Core Satellite Portfolio falls under a major category called enhanced indexing which entails a combination of both passive and active strategies.

Firstly, let’s analyze passive and active.

Passive Investing

Passive investing can be defined as purchasing an index fund and holding. In many cases, investors will purchase a Vanguard fund and hold until retirement. There’s minimal turnover which means low commission costs. Additionally, passive investing has:

  • Sharpe Ratio: Very close to or equal to 1.0
  • Beta: Very close to or equal to 1.0

Active Investing

On the other hand, active investing is pretty much the opposite of passive investing. Investors continuously buy and sell stocks. The turnover rate is very high, and so commission costs are high. Additionally, active investing has:

  • Sharpe Ratio: Less than 1.0
  • Beta: Higher than 1.0

Enhanced Indexing: Hybrid Investing

Enhanced Indexing takes a hybrid approach using both passive and active strategies. The enhanced indexing approach attempts to track the market. However, the portfolio will be tailored towards certain strategies. My core satellite portfolio is one of these strategies.

To illustrate, imagine an investor who buys the S&P. Buying and holding the S&P is a passive approach and follows the index. Following this scenario, an investor can buy an S&P ETF or attempt to replicate it by buying all 500 stocks. Afterwards, the investor will hold it forever while continually adding more shares.

To transform from passive into hybrid, the investor will mix in a flavor of their own strategies. For example, a very popular strategy is market timing. An investor will buy S&P when they think the market is at a bottom,. The investor will then sell when they think it’s at the top.

Additionally, an investor may attempt to overweight certain stocks in the S&P and underweight others. They may do this to entire sectors within the S&P as well. For example, let’s say that this same investor believes that financials and technology will do better than the rest of the market. So for an enhanced indexing approach, they would buy the S&P, but then allocate a higher percentage of the portfolio towards financial and technology stocks.

Enhanced Indexing Illustration

Below is an example of a before-and-after picture of an investor actively allocating to the sectors that they believe will outperform.

The Before Picture: A Purely Passive Approach Holding an Equal Weight in All Sectors

S&P 500 Equal Weighted Sectors

The After Picture: If I Believe Financials and Tech Will Outperform, Then I Overweight Those Sectors

S&P 500 Sectors Modified

This is only one illustrative example of an enhanced indexing strategy. The enhanced indexing strategy can utilize multiple strategies. As a result, enhanced indexing has produced the highest Sharpe Ratios compared to passive or active alone. A number of enhanced indexing strategies have been made popular:

  • Enhanced Cash
  • Index construction enhancements
  • Exclusion rules
  • Trading enhancements
  • Portfolio construction enhancements (Core Satellite Portfolio)
  • Tax-managed strategies
  • Smart beta
  • Factor investing

Enhanced Indexing Strategy: The Core Satellite Portfolio

My version of enhanced indexing is building a Core Satellite Portfolio. The “core-satellite” is named for having a core portfolio, surrounded, or orbited, by satellite investments. The core represents the passive part of enhanced indexing. The satellites represent the active strategies that the portfolio manager is implementing.

A huge chunk of my portfolio is in SPY, the S&P 500 ETF. This is the core of my portfolio. This represents the passive part that tracks the market. Also, I chose SPY as it’s one of the most liquid securities on the market. Its liquidity factor extends to its options too.

The rest of my portfolio is allocated into stocks that I believe will outperform. Those are the satellites of my portfolio.

core satellite portfolio

As you can see above, the core satellite portfolio is similar to a planet orbited by moons. Additionally, my strategy includes selling cash-secured put options on SPY whenever there’s a dip in the market. Worst-case scenario is that I will be assigned more shares of SPY. And I am not against owning SPY whatsoever. When I believe there’s a peak, I’ll sell covered calls against my shares of SPY to enhanced returns and produce income. This strategy of selling puts and calls on SPY is an attempt to time the market. Which is also another part of enhanced indexing.┬áThe addition of options to passive investing could enhance returns by adding an income component for lower risk (since the biggest risk factors would consist of opportunity cost and systematic/market risk ).

Growth and Value

To identify the active components of my core satellite portfolio, I planned to allocate between growth and value stocks. My growth components mainly consist of large cap, momentum, and trendy stocks. There are lot of people who don’t like to purchase big name stocks like Google and Amazon. I simple tell them that they’re more likely implementing a contrarian strategy. And there’s nothing wrong with that. Everyone has different strategies. And all strategies will work at some time or another.

My value component consists of stable, mature companies that pay a dividend. Companies that have long since left their growth phase. Choosing and picking ideologies from the Warren Buffett way of investing, I will add to my positions when the stocks of strong companies dip and appear cheap. Then I dollar cost average my way into positions.

These combinations of value and growth stocks are satellite in my core satellite portfolio.

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4 thoughts on “The Core Satellite Portfolio”

  1. Good read! Have you considered writing a tutorial on how to sell cash secured-puts and covered calls? You also mention purchasing stable, mature companies that pay a dividend during a dip. If those companies never “dip”, does that mean your money for that month goes directly into the core?

    • Thanks for the suggestion. I’ll brainstorm a post around that topic and write it up since selling CSPs is how I enter into my stock positions (note how they’re all in quantities of 100). If these companies never dip and I have enough cash sitting around, I usually use that to boost up an existing position by writing CSPs.


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