The core-satellite approach splits a portfolio into two parts: the main part, called the core, and a much smaller portion, called the satellite. The core generally consists of “boring” but steady long-term performance (often index funds tracking market portfolios), while the satellite can be anything that could complement the core with risk diversification, outperformance potential, or both. This way, you could have the benefits of a diversified portfolio, an opportunity to outperform the market, and the advantage of lower management and transaction costs.

For income-seeking investors with core holdings of market portfolios like the S&P 500 and the S&P/ASX 300, the S&P/ASX 300 Shareholder Yield Index and the S&P 500 Low Volatility High Dividend Index can be compelling satellite options for their attractive dividend yield and high active share.[1]

Attractive Dividend Yield

The trailing 12-month dividend yield averaged 5.02% for the S&P/ASX 300 Shareholder Yield Index from its launch in December 2014 to October 2019 (see Exhibit 1). The S&P 500 Low Volatility High Dividend Index also posted an impressive 4.11% average dividend yield from its launch in September 2012 to October 2019.

High Active Share

Since January 2015, the active share of the S&P/ASX 300 Shareholder Yield Index against the S&P/ASX 200 averaged 74%. For the S&P 500 Low Volatility High Dividend Index versus its benchmark, the number was 85%. This means that both indices could be more “active” than many active yield-focused funds offered in Australia and can complement a core index holding in an investor’s portfolio.

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Implementing the Core-Satellite Approach with the Two Dividend Indices

If your core is the S&P/ASX 300 or the S&P 500, how would your portfolio look like if you moved some capital to the corresponding dividend index? Exhibits 2 and 3, which depict the risk/return profiles of 11 combinations of core and satellite, provide a visual illustration of the effects.

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Over the past 15 years, a 100% S&P 500 portfolio generated 8.9% annual total return, with 12.3% annualized volatility (in AUD; see Exhibit 2). When the allocation moved to the S&P 500 Low Volatility High Dividend Index by 10%, 20%, 30%, etc., the risk/return point moved toward the top left of the original portfolio, which means higher return and lower risk. For example, at the 50/50 allocation, the total return increased 80 bps to 9.7% per year and volatility decreased to 11.8%.

Similarly, moving capital from an S&P/ASX 300 core holding to the S&P/ASX 300 Shareholder Yield Index could also improve portfolio risk/return (see Exhibit 3).

The curves in Exhibits 2 and 3 reveal how diversification improves a portfolio’s risk/return profile, or what is called the “efficiency” of portfolios. It could be used as a guide to help investors implement the core-satellite approach.

[1] Wang, Izzy and Tianyin Cheng, 2019, TalkingPoints: The S&P/ASX 300 Shareholder Yield Index.