Lesson 2: Building and optimizing ETF portfolios

Hello, Tigers!

In the previous lesson, we discussed how to quickly select three key types of ETFs and how to combine them to achieve your expected returns. Today, I am delighted to introduce you to the "Core and Satellite" strategy for ETFs.

1. Core & Satellite strategy: Constructing a powerful investment portfolio

First, what is the Core & Satellite strategy?

The "Core & Satellite" strategy, which originated in the 1990s, has evolved into one of the primary asset allocation methods in the global investment arena. Leading asset management firms worldwide, including Vanguard and UBS, have embraced and applied this strategy.

In essence, this strategy segments your investment assets into two distinct categories: "Core" and "Satellite." The larger portion of your investment capital is allocated to the "Core," while a smaller portion is designated for the "Satellites."

While you may have just one "Core," it is possible to have multiple "Satellites." The objective of this strategy is to strike a balance between secure, stable returns and risk diversification.

The "Core" assets primarily serve the purpose of managing one's ETF portfolio's risk exposure, while seeking to generate relatively consistent returns. In contrast, the "Satellite" assets are allocated to assume a certain measure of risk, albeit with a smaller allocation, in pursuit of potentially higher returns.

With this understanding of the Core and Satellite strategy, let's explore its practical application:

The primary "Core" component can comprise of passive, low-cost, and relatively liquid currency ETFs or broad-based index ETFs.

The secondary "Satellite" component may encompass more high-risk investment choices, such as industry-specific ETFs or leveraged/inverse ETFs, with the aim of potentially boosting returns. Typically, these selections are associated with industries characterized by higher volatility or leveraged/inverse ETFs.

Let's look at different types of portfolios, we can put together:

（1）Conservative Portfolio

The goal of a conservative portfolio is to reduce volatility and achieve consistently stable returns, making it suitable for investors with a lower risk appetite. You can consider pairing low-volatility currency fund ETFs.

For example: Core: Currency ETF + Satellite: Another Currency's ETF Core: Currency ETF + Satellite: Broad-based Index ETF

（2）Balanced Portfolio

A balanced portfolio aims to achieve moderate returns while also limiting portfolio volatility, making it suitable for investors with a moderate risk appetite. You can consider pairing broad-based index ETFs with high dividend ETFs.

For example: Core: Broad-based Index ETF + Satellite: High Dividend ETF Core: Broad-based Index ETF + Satellite: Broad-based Index ETF

（3）Aggressive Portfolio

The aggressive portfolio aims to tolerate some volatility in exchange for higher returns, making it suitable for investors with a higher risk appetite. This portfolio can include sector-specific ETFs and leveraged/inverse ETFs.

For example: Core: Sector ETF + Satellite: Leveraged ETF Core: Sector ETF/Broad-based Index ETF + Satellite: Leveraged ETF

2. Evaluation of Historical Performance of ETF Strategy

How would these 3 types of ETF portfolios perform in terms of returns and risks? The Tiger Research Team conducted data backtests at different time periods for each of the three portfolio types.

（1）ETF Portfolios and Weightings:

(Note: This form is for illustration purposes only, and it is not financial advice.)

1. Balanced - Stock Index Portfolio: This portfolio adopts a balanced approach by selecting five ETFs, each with an equal allocation. The selected ETFs are as follows:

   1. CSOP HS TECH

   2. CAM NASDAQ100

   3. X CSOPCSI 500

   4. PING AN HKDIV

   5. CAM JAPAN HDG

   6. A CSOP HKD MM

2. Aggressive - Multiple Themes Portfolio: In contrast, the Aggressive portfolio is designed for investors seeking potentially higher returns and are willing to embrace a greater level of risk. This portfolio comprises four distinctive types of ETFs, each allocated an equal weight. They include:

   1. Leveraged ETFs

   2. New Energy ETF

   3. Cloud Computing ETF

   4. Hang Seng Tech Index ETF

By focusing on these specific areas, the Aggressive portfolio aims to capture opportunities in high-growth sectors and leveraged instruments while still maintaining an equal allocation strategy.

（2）Portfolio Backtest Performance Statistics

（Source: Tiger Investment Research Team. These hypothetical backtested results are gross of fees. They do not represent the results of actual tradings for the period selected, nor imply that they could be relied upon for future performances. They are purely for illustration purposes only. An underlying's weighting is "rebalanced" monthly. This is not financial advice.）

In summary:

Portfolios with leveraged/inverse and sector-specific ETFs could yield higher returns but they also come with higher volatility and drawdown risk. For a stabler portfolio, you can consider allocating more to cash fund ETFs or broad-based index ETFs as "Core."

This is not a one-size-fits-all formula. Customize your ETF portfolio based on your risk tolerance and give the Core-Satellite strategy some thought.

This concludes our lesson for today. Tiger Friends, see you at the next one!

For other ETF-related courses, please click on the links below: "ETFs for beginners" and "Advanced Course on Hong Kong ETFs".