Core & Satellite portfolio construction arose out of the failure of Modern Portfolio Theory (MPT) to protect portfolios from downturns. Many advisers now understand that MPT doesn’t work, it just appears to work during an up market (along with everything else). The obvious solution is a 100% tactical approach but for many going from 100% buy and hold to 100% tactical is too much to ask (even though it is a better way) hence the development of Core & Satellite. The idea is to mantain a 60-80% buy and hold core that would be in an index fund that tracks something like the S&P 500 or the Russell 3000. You could also include an international index fund and bonds. The remainder of the portfolio would be the satellite which would include defensive and opportunistic investments.
While this beats MPT, you are still subject to massive losses in a down market. A major improvement on this idea would be a 100% tactical Core & Satellite Portfolio. To see how this works we did the following:
1. Created a core that puts 40% in a tactical strategy that rotates between the S&P 500 (SPY) and bonds, 10% in a strategy that rotates between the MSCI EAFE (EFA) and bonds, and 10% in a strategy that rotates between Emerging Markets (EEM) and bonds.
2. Created 4 satellites and put 10% in each. Satellite one rotates among a basket of 2x levered index funds or ETFs, Satellite two rotates among a number of different asset classes, Satellite three rotates among a number of defensive assets—-Gold, Swiss Franc, etc, and Satellite four is a VIX hedge.
We ran the numbers using TradersStudio software from 4/19/05 to 4/11/2012. We did not include commissions as I can buy and sell most of these without them. We also did not includes fees or taxes. The results are as follows:
Average Annual Return: 16.04%
Maximum Drawdown: -8.79%
Best Month: 10.35%
Worst Month: -3.90%
Sharpe Ratio: 1.3065
2008 Return: 14.80%