Building a core and satellite portfolio of EV stocks is one of many wise investing strategies. It’s necessary that we first understand what a core and satellite portfolio is. As its name suggests, this strategy involves dividing a portfolio into a central (core) portion and other non-fixed, more flexible (satellite) portions.
Investors know that diversification is key to managing risk and finding sustained gains. And investors know that learning how to build their own core and satellite portfolio is a great way to protect themselves while maximizing upside.
Another aspect of core and satellite investing is that it blends active and passive investing strategies. That is, part of the portfolio is invested in passive, non-managed index funds while the other portion is actively managed. There are pros and cons to active and passive investment management individually. This approach seeks to mitigate risk while making allocations for risk. Thus, some investors consider this approach to be the best of both worlds.
Investors can apply this approach on a broad scale by investing in index funds at the core, rounded out by active, riskier satellite investments. Investors might do so across their entire portfolio. However, it is also possible to drill down and apply this approach to a portion of a portfolio. For example, by dedicating a portion of one’s entire portfolio to a sector. Further, investors could focus on a single sector, for example EV stocks.
The purpose of this article is to educate readers first about core and satellite investing strategies. Then this article is going to apply that to EV stocks. Investors will gain an understanding of how to build their own core and satellite portfolio of EV stocks.
Index Funds and Exchange-Traded Funds (ETFs)
The core portion of the approach generally relies on an index fund. An index fund is a grouping of stocks taken from a certain index, for example the Nasdaq Composite, S&P 500 or Russell 2000. Index funds are intended to mirror the returns of the index from which they are derived. This is called beta. So theoretically, an index fund comprising 50 Russell 2000 stocks should provide the same return (beta) as the entire index averaged.
I’ll get around to the benefits of index funds later, but for now, I want to focus on how investors need to approach this method focused on EVs, and not an entire index.
Investors will need to use ETFs to seek beta. ETFs approximate index funds in many ways. Basically, they are the same in that they represent a broad grouping through a smaller grouping. Another way of thinking about this is to say that we’ll be indexing using ETFs.
Characteristics of Index Funds and ETFs
Investors like index funds because of their predictability. Compared to actively managed funds, index funds have all of the following characteristics:
- Lower Cost
- Lower Risk
- Approximates Beta
- Longer term
- More Tax Efficient
Index funds cost less because there is no one managing them. Index funds are a selection of stocks meant to approach beta. They are not managed by fund managers aggressively seeking to beat the market. So, index funds don’t include fees for such management. Index funds are lower risk because they represent a diversified set of stocks. Theoretically, an index fund should have the same risk as an entire index. And indices are generally safe.
Index funds approximate beta, and their purpose is to match the gains of the broader market. They are also longer term as most investors ride their ups and downs with the prevailing markets. Lastly, index funds are more tax efficient because they don’t trigger capital gains taxes. Why? Their asset mix generally remains the same. They have low asset turnover compared to actively managed funds.
Characteristics of Actively Managed Funds
The active approach is basically the polar opposite of the index approach. Actively managed funds are overseen by fund managers and have unique characteristics.
- Higher Cost
- Higher Risk
- Seeks Alpha
- Short Term
- Less Tax Efficient
Actively managed funds come with higher expense ratios due to the fund managers overseeing them. They are also higher risk as their purpose is to beat the market. That is, they seek alpha. Actively managed funds are shorter term in their approach to seek gains. This is not a buy-and-hold strategy. Because there is higher portfolio turnover in actively managed funds, capital gains taxes can be triggered. This makes them less tax efficient overall.
Blending the Two Styles for a Core and Satellite Portfolio
The purpose of core and satellite portfolios is to mix both styles, adjusted for the individual risk profile. Basically investors should choose a risky core investment, and then a satellite investment. For some investors that will mean a larger, safer core, and a smaller satellite to seek return. For others, the opposite will be true.
So now that the basic educational component of core and satellite portfolio investing is under our belts, we need to apply this to EV stocks. The first step is going to be finding an appropriate EV ETF with which to form the core.
Keep the Core Simple With EV Stocks
The most logical investment strategy here is to choose from the top electric vehicle ETFs. There are three that come to mind. Yet, remember that if and when you decide to do this yourselves, there are many other EV ETFs from which to choose.
- Global X Autonomous & Electric Vehicles ETF (NASDAQ:DRIV)
- iShares Self-Driving EV & Tech ETF (NYSEARCA:IDRV)
- SPDR S&P Kensho Smart Mobility ETF (NYSEARCA:HAIL)
Global X FDS ETF (DRIV)
Expense Ratio: 0.68%, or $68 on an initial $10,000 investment
The DRIV ETF follows the Solactive Autonomous & Electric Vehicles Index. Tesla (NASDAQ:TSLA) comprises 3.6% of the total portfolio. Toyota (NYSE:TM) is one of the only other automakers among the top 10 holdings. Chipmakers and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) round out the other top holdings.
iShares Self-Driving EV & Tech ETF (IDRV)
Expense Ratio: 0.47%
IDRV follows the NYSE FactSet Global Autonomous Driving and Electric Vehicle Index.
The top 10 holdings in the IDRV ETF are very similar to those in the DRIV ETF, with allocation being the primary difference. Tesla comprises 8.2% of the total portfolio in this one though, which is much higher. Otherwise, it bears many similarities with the aforementioned DRIV stock.
SPDR S&P Kensho Smart Mobility ETF (HAIL)
Expense Ratio: 0.45%
The HAIL ETF follows the Kensho Smart Transportation Index. The top four holdings in it are Nio (NYSE:NIO) at 12.2%, Plug Power (NASDAQ:PLUG) at 6.7%, Workhorse (NASDAQ:WKHS) at 4.6% and Tesla at 3.7%.
Investors who want to create their own core and satellite EV portfolio could start here. Any of these three ETFs constitute a strong core. Each of these ETFs has a very similar graph which is indicative that they actually are doing the same thing. That is, they follow indices and general trends.
A Satellite Strategy for EV Stocks
This is where investor risk, style and direction are really going to come into play. With the core out of the way, investors need to consider their individual approach to the satellite portion of the portfolio. There are many choices. First of all, investors must decide what portion of their total portfolio is going to be allocated to riskier satellite investments. This will have been done beforehand, but the point is that risk-seeking investors will dedicate more capital. Risk-averse investors will dedicate less.
Next, investors have to consider how to direct this capital. There are really a lot of choices here. So, I’ll mention a few possibilities for the purpose of illustration. For example, investors could look at a particular portion of the EV supply chain and identify an ETF therein. Likewise, investors can search for an actively managed ETF with a heavy allocation toward an individual stock they believe will appreciate. Investors who choose to do this need to really consider their own perspectives and investment styles.
So, back to the idea of focusing on a portion of the EV supply chain and a managed ETF heavily weighted toward a single stock. Two ETFs which exemplify that strategy are:
Global X Lithium & Battery Tech ETF (LIT)
Expense Ratio: 0.75%
This fund invests 80% of its assets in companies that are economically tied to the lithium industry. The play here is that lithium is an essential commodity in the production of EVs. Many of its top holdings are lithium producers. Tesla also makes the cut.
ARK Innovation ETF (ARKK)
Expense Ratio: 0.75%
The ARKK ETF directs 65% of its assets toward disruptive innovation. It is much more diversified in terms of sector and industry coverage, but Tesla is its primary holding. Tesla comprises 9.7% of ARKK’s portfolio.
Creating a core and satellite portfolio is one of the smartest investing strategies there is. Investors need to remember that it is deceptively simple in that it only really requires identifying two pieces. However, doing so requires a lot of research and reflection on individual investment styles.
On the date of publication, Alex Sirois did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Alex Sirois is a freelance contributor to InvestorPlace whose personal stock investing style is focused on long-term, buy-and-hold, wealth-building stock picks. Having worked in several industries from e-commerce to translation to education and utilizing his MBA from George Washington University, he brings a diverse set of skills through which he filters his writing.