Overall investment portfolios can be separated by core and satellite strategies, each with a different purpose. The core of a portfolio is usually the beta element, which provides exposure to market risk, sometimes through smart beta indices. The attraction of the beta portfolio lies in the ability to passively and cheaply generate the long-term returns associated with market exposure.
The satellite component adds alpha and diversification to the total portfolio by providing extra return over the long term while potentially acting like a cushion in the case of a market dip. Among the numerous sources of alpha, one approach is the use of cross-asset class risk premia.
Combining core and satellite portfolios can make the overall portfolio stronger and more resilient. In a bull market, the core portfolio tends to perform well, but when the market turns or when volatility spikes, the low correlation between the two portfolios acts as a buffer against losses. In the case of a bear market, the alpha portfolio can maintain positive returns irrespective of market conditions.
Alpha-beta separation is a common investment technique that allows investors to have more control over the total portfolio’s underlying risks. After allocating the appropriate amount of capital to the beta portfolio, investors can direct surplus capital to the alpha fund.