ESG: Satellite and Core

By EBI Portfolios

Posted on December 6, 2019 under finance

The concept of “satellite and core” is a key discussion among financial advisers when it comes to portfolio construction. In essence, core investments make up a bigger proportion of long-term invested assets, and tend to be passive funds, while the satellite can perhaps include some riskier or more exotic active investments for the shorter term and tactical plays.

This model is designed to lower costs, be more tax efficient, minimise volatility and provide some opportunity to outperform the markets - and it can be applied across investment vehicles, strategies, and asset classes. (Although it’s not to be confused with the typical way we talk about equities versus bonds - say, 60% for the former and 40% for the latter for a typical medium-risk portfolio - because both are typically longer term.)

And this is where ESG comes in. So, do you hold ESG at the core or satellite?

For many advisers who are still unfamiliar with it, they may prefer to hold a lesser proportion of ESG versus traditional ‘mainstream’ active and passive funds.

But as our blog series has demonstrated, advisers are not necessarily sacrificing returns by investing in ESG. They are not paying higher than average fees, or dealing with liquidity or trading issues, compared to ‘normal’ funds. Admittedly, ESG ETFs do have to catch up in terms of track record - but since they are based on indexes and not active managers’ decisions, past market performance has no bearing on future returns. An ESG ETF, like any other, is replicating the ups and downs of its underlying index.

If, as an investor, you are agnostic or open-minded towards ESG, there is no reason why a portfolio of ESG ETFs shouldn’t make up the core of an investor’s portfolio. ESG ETFs cover the same markets (or most of them) as traditional funds, therefore they can be used to build a lower or higher risk portfolio, as per client requirements.

For example, you might hold a higher proportion of assets in government bonds, US, UK and European equities at the core, but invest a smaller amount in corporate bonds, emerging market equities or even alternative strategies at the satellite - and ESG ETFs allow you to do this too.

The only distinctions from a very traditional core/satellite model are, first, the vehicle itself - the ETF, which is low-cost, transparent and tax efficient compared to traditional mutual funds. (Many financial advisers use passive index funds instead of ETFs.) The second distinction is the ESG component, which focuses on environmental, social and governance factors, and usually means that certain stocks or sectors are stripped out of a traditional index. And the third, arguably most debilitating distinction, is the lack of current choice of ESG options to populate each asset class - which we hope is a temporary scenario.

In EBI’s new Earth portfolios, the core is invested into ESG Enhanced funds with iShares ETFs which track developed and emerging markets. At the satellite of the Earth portfolio, the firm is invested in a systematic factor based fund - GSI Global Sustainable Value. Therefore, our allocation subscribes to the traditional core-satellite model. For the time being, all of the other asset classes that EBI holds are either not available at all, or are too expensive in our view.

But as ESG investing grows in scale, and more ETF providers get on board, there’s no reason that all asset classes cannot be covered with an ESG screen.

Over time and as more ESG offerings appear, we might even get to what this asset manager describes as “core and specialist ESG” within the core/satellite framework - maybe made entirely from ETFs. Time will tell.