ETFs: A question of balance

Providers jumping on the balanced funds bandwagon

The other day over dinner a friend issued me a challenge: “Suppose I gave you a million dollars to invest, but you could only put it in two securities. Not funds, just stocks or bonds,” he said. “Which ones would you choose?” I didn’t have to think twice before answering.

“None,” I replied. “It’s not an option anyone should consider. That’s not investing, it’s a crap shoot.”

At first, my friend was taken aback by this answer, but after I explained he began to come around. One of the keys to successful investing is diversification. As I have written before, no one can predict with certainty what is going to happen in the financial world. Stocks that looked like sure winners one day end up being hammered the next. Look what happened to the big technology companies recently after reports emerged that the U.S. Department of Justice is looking at launching an antitrust investigation into their business practices. Shares of Facebook, Apple, Amazon, and Alphabet tumbled. Then there was the $18 billion drop in in the value of automotive stocks after U.S. President Donald Trump unexpectedly threatened to slap new tariffs on Mexico in an effort to stem the tide of illegal immigration.

The message is clear: Take nothing for granted. That’s why I always want to see the maximum possible diversity in a portfolio. That doesn’t stop with a proper allocation of stocks, bonds, and cash. It includes geographic, sector, and currency diversification as well.

Two securities couldn’t come close to achieving that. It would be putting all the eggs in two baskets and hoping an elephant doesn’t decide to sit on them.

The best way for most people to achieve proper diversification is through the use of balanced funds, which offer a combination of stocks, bonds, and cash. They have been the backbone of the mutual funds industry for many years. As of the end of April, more money was invested in balanced funds (almost $800 billion) than in all other segments combined (equity, bonds, specialty, and money market). That’s according to figures released by the Investment Funds Institute of Canada (IFIC).

But when you look at the way we invest in exchange traded funds (ETFs), it’s a totally different story. According to IFIC’s numbers, Canadians have invested only $3.6 billion in balanced ETFs. That’s about 2% of the total amount invested in the rapidly growing ETF market.

Why the huge discrepancy? Basically, because ETF providers haven’t provided the products. Until very recently, they seemed to take the view that investors weren’t interested in balanced ETFs, despite the obvious huge appetite for them on the mutual fund side.

I suspect the reason for this goes back to the origins of ETFs in the late 20^th century. They were originally created as a low-cost option to track the performance of major stock indexes of the time, like the Dow Jones Industrials, S&P 500 Composite, and the TSX Composite. That made the ETFs easy to understand.

Over the years, they have become increasingly complex, tracking more obscure indexes and even introducing active management. But they continued to shy away from balanced portfolios, perhaps because they can be complicated to benchmark.

New balanced ETFS

Now that is changing. Vanguard recently launched a line of four balanced funds. They offer asset allocations ranging from 20% equity/80% fixed income to an 80/20 split the other way. The higher the level of stocks, the greater the risk. They all offer low fees (0.25% management expense ratio, or MER) but none have produced impressive results so far. The best has been Vanguard Conservative ETF Portfolio (60% bonds, 40% stocks), with a one-year gain of 6.21% to Aug. 31. It trades on the TSX under the symbol VCNS.

Vanguard isn’t the only ETF provider to suddenly discover there may be a lot of potential business in balanced funds. In February of this year, BMO announced the launch of three asset allocation funds. The BMO Conservative ETF (TSX: ZCON) targets a mix of 60% fixed income, 40% equity. The BMO Balanced ETF (TSX: ZBAL) aims for 60% equities, 40% fixed income, while the BMO Growth ETF (TSX: ZGRO) is the more aggressive with 80% in equities and 20% fixed income. All funds have a MER of 0.2%.

Blackrock’s iShares, the largest ETF provider in Canada, has two balanced offerings. The iShares Core Growth ETF Portfolio (TSX: XGRO) invests in a mix of eight other iShares funds, with an allocation of roughly 20% fixed income, 80% equities. As of Aug. 31, the year-to-date return on this fund was 11.6%. The MER is 0.84%.

The iShares Core Balanced ETF Portfolio (TSX: XBAL) is ahead 10.7% this year to Aug. 31. It offers a more conservative approach with a portfolio mix of about 60% equities and the rest in fixed income and cash. The MER is 0.76%.

If you’re interested in an actively-managed fund, check out the Horizons Balanced TRI ETF Portfolio (TSX: HBAL), which was launched in August of last year. It invests in a portfolio of other Horizons funds, targeting a mix of 70% equities, 30% fixed income. It’s ahead by 13.9% so far in 2019. The MER is 0.16%.

Horizons also offers the less aggressive Conservative TRI ETF Portfolio (TSX: HCON), which has a 50-50 mix of stocks and bonds. It too has only been around since last August. The year-to-date return to Aug. 31 is 12.5%. This one has a MER of 0.15%.

As you can see, there are now a lot of balanced ETFs options from which to choose, with the list growing all the time. Most of these funds are very new, so picking potential long-term performance leaders is a guessing game at this stage. My advice is to decide on the asset mix that you are most comfortable with and go with the provider that offers that option at the lowest cost.

Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder and The Income Investor newsletters, which are available through the Building Wealth website.

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Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting, or tax advice. Always seek advice from your own financial advisor before making investment decisions.