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Portfolio > Portfolio Construction

ETF Cores and Satellites

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The roster of U.S. listed ETFs has skyrocketed from less than 300 to more than 2,000 products over the past 10 years. Yet, the surge in professionally managed ETF portfolios is now outstripping the impressive growth of ETF products.

Although the idea of managed ETF portfolios was originally introduced in traditional separately managed accounts, it has now expanded into UMA platforms, hedge funds, and even mutual fund companies employing a fund-of-fund approach. As of early 2015, there were 700 strategies from 151 firms with total AUM near $86 billion, according to Morninstar.

A significant portion of assets in ETF portfolios are coming from platforms like AssetMark, Envestnet and third-party RIAs including so-called “robo-advisors.”

The sheer number of ETF portfolio strategies leaves the prudent advisor with no choice but to discriminate. And in this article, we’ll examine a timeless and proven strategy for building and managing client ETF portfolios. This approach is sometimes referred to as “core/satellite” and it involves dividing a portfolio’s assets into two key containers: a core and non-core portfolio. Let’s evaluate each of these containers and how they work together.

Core Portfolio

Before discussing with clients which ETF components will make up their portfolios, advisors should convince customers on the importance of obtaining maximum diversification. This begins by recognizing and accepting that a portfolio with authentic diversificaiton should have market exposure to the five major asset classes: stocks, bonds, commodities, real estate and cash. Put another way, a diversified portfolio isn’t truly diversified unless it’s truly diversified!

Another way to imagine a client’s core portfolio is as the portfolio’s foundation. This means the bulk of a client’s total portfolio (51% or more) will be invested in ETFs with the absolute broadest exposure to the four major asset classes: stocks, bonds, commodities and real estate. What types of funds should an advisor select? Not only should the ETFs chosen for a client’s core portfolio be diversified, but they should also be accurate proxies of the asset classes where they invest. This would automatically eliminate ETFs that exclude securities by investing in a narrow sector or country, along with funds that are actively managed, from being used as “core holdings.” Remember: The singular goal of a core portfolio is always to obtain maximum diversification with its holdings.

One advisor who uses the core portfolio methodology for building investment portfolios is Larry Steinberg, a financial advisor with Financial Arcitects based in Pasadena, California. “The SPDR Dow Jones Global Real Estate ETF (RWO) is among my core holdings.” RWO offers both international and domestic exposure to publicly traded real estate companies and the $1.83 billion fund charges annual expenses of 0.50%.

“Being an endowment model advisor, you will never see any individual or institutional account be all in ETFs. I use a lot of alternative investments, many of which are illiquid, especially for fixed income. However, you will see all of my liquid equity positions be in ETFs,” adds Steinberg.

Non-Core Portfolio

A non-core investment portfolio is always complementary to a person’s core portfolio and is much smaller in size relative to the core. Likewise, the non-core portfolio is characteristically higher risk because it has freedom to invest in more narrowly focused non-core assets like active funds, individual stocks, single country funds, regional equity funds, industry sector funds and leveraged long/short strategies.

“We trade the most liquid markets such the SPDR Gold Shares (GLD),” said Frank R. Stanley, president of Global Wealth Management. Stanley manages a liquid ETF global marcro program called Octane for the Claraphi Advisor Network. GLD is a perfect example of non-core ETF because it represents a narrow segment of the commodities market. “When you are trading less liquid ETFs and ETN markets the dislocations can create pricing concerns. We try to avoid that by sticking to the deepest and most liquid exchange traded funds and notes,” said Stanley.

The recent uptick in stock market volatility has lifted interest in volatility focused ETPs and these types of products are another example of non-core investments. Because volatility is a non-core asset class, products linked to its performance — including funds that attempt to minimize its effect — would rightly be kept in a client’s non-core portfolio.

One way to explain the relationship between a person’s core and non-core portfolio to clients is like this: A person’s non-core portfolio is the appetizer, the core is the main course. Who in their right mind would overstuff themselves on appeatizers and leave no room for the main meal? For this reason, it’s logical to expect that a person’s non-core ETF investments would represent no more than 49% of a portfolio’s total value. Why? Because if it accounted for anything more, it would wrongly overtake the role of the core portfolio as the foundation of the client’s assets.

Portfolio Implementation

How an advisor goes about implementing ETF portfolios is a matter of philosophy. Some advisors like to maintain strict control by keeping the entire process in-house whereas others farm out the work to third-party managers.

In his bestselling book “Unconventional Success: A Fundamental Approach to Personal Investment” (Free Press, 2005) legendary investor David F. Swensen, Yale University’s chief investment officer, popularized one relatively simple portfolio implentation strategy.

Swensen described a “well-diversified and equity oriented portfolio framework for investment success” as one that holds exposure to stocks in foreign developed, emerging markets and the U.S., plus real estate, U.S. TIPS and U.S. Treasuries.

Using Swensen’s formula, David S. Kreinces, founder and portfolio manager at ETF Portfolio Management, built a series of ETF models he calls “investable benchmarks.” The investable benchmark are three all-ETF portfolios that are developed into income, growth and income and growth buckets. “These are meant to be core portfolios with maximum diversification with low cost,” said Kreinces.

The three equity asset classes used by Kreinces are U.S. equity, foreign developed and emerging markets, along with two bond positions (intermediate U.S. Treasuries and U.S. TIPS) and U.S. REITs. “The reason why Swensen applied these asset classes, is the fact they aren’t highly correlated, which thereby reduces risk and increases diversification,” he states.

All the investable benchmarks use ETFs from iShares and Vanguard to invest in these asset classes. The iShares are the bond companents while Kreiences uses Vanguard for the other holdings.

Kreinces’ portfolios are available as separate accounts via Charles Schwab. His fee is 0.25% annually and the underlying ETFs charge another 11 to 16 basis points for a total cost near 0.36% to 0.40%. He combines these portfolios with a trend following strategy. He argues that indexing and trend following are doing the same thing but at different speeds.

“ETFs have grown to where ETFs are the choice vehicle for portfolio management by both institutional and retail investors. That should enable ETFs to offer clients a more efficient solution at a lower cost.”


Dividing a portfolio into core and non-core parts helps advisors to build, manage, and organize client portfolios. Each distinct container is complementary and avoids needless duplication because it serves a different function by deliberately doing something different.

The core portfolio will always aim for maximum diverisfication across the major asset classes. And the most tactical a core portfolio will ever be is when it rebalances or adjusts its exposure to each asset class. In contrast, the non-core portfolio takes a tactical approach by investing in assets that are more risky, volatile, and narrow with a return profile that should be equally high.


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