02/14/2011

ETFs are becoming ubiquitous and there are increasing numbers that "do the same thing." ETFs are much more accessible to the general public and with increasing numbers of brokers offering low or no commission trades provided they are held for a month or more, it may be hard to know which ETF to select.

MyPlanIQ has recently completed a major review of all the leading ETFs in the US Equities asset class and we are going to dig a little deeper to determine which ETFs would provide the highest returns. We start with the large cap blend ETFs.

The first thing to note is that none of the large cap blend ETFs come in the top ten list of the US equity ETFs. RSP is 19th, VTI is 26th and SPY is 30th.

The second thing to note is that RSP has a clear win against VTI and SPY. There is a great deal of debate about whether equal weight equities make sense but, in pure returns terms, they clearly perform better.

 We observe that RSP has more volatility and does better in good times and worse in bad times. We also observe that VTI and SPY have similar performance characteristics.

When we go back to performance of all ETF's in the US asset class we note that the top ten comprises four small cap, five mid cap and one large cap ETFs.

Being equally weighted means that the smaller companies (albeit in the large cap class) have a larger percentage of the portfolio in RSP than in VTI and SPY. Therefore, it leans more towards mid cap behaviors.

In times of financial stress, the larger caps are going to be preferred which would favor SPY and VTI but when things are recovering, the smaller company leaning RSP is going win out and that is what happens.

When it comes to expenses, RSP is the most expensive to own. Their cost is 0.4% whereas Vanguard is 0.07% and Spyder is 0.0945%. This makes RSP a relatively expensive ETF to own but the returns are there as the returns reported are net of management fees.

If your investment strategy is to fire and forget then maintaining some large cap equities is going to be important to get through future financial heavy weather that will come sooner or later -- RSP and VTI.

If you are going to have regular reviews and be willing to move from mid cap to large cap, then RSP is a reasonable hedge but you might decide to leave out large cap blend subclass all together for now.

Symbols:IJK,VBK,QQQQ,MDY,IWO,IJT,IJH,VB,VXF,IWP,IJR,VO,VOT,IWR,IJJ,VBR,IJS,IWN,RSP,IWM,IWS,VOE,VTV,IWC,SCHA,VTI,DIA,VUG,IWF,SPY,IWB,SDY,IVW,VIG,IVV,IWD,OEF,IVE,DVY

Tags, ETFs, US Equity, Portfolio Construction

comments(0) 

07/09/2010

Portfolio construction consists of the following steps

• Decide personal risk profile which determines the target allocation in risk assets.
• Decide asset allocation method: strategic or tactical or both (strategic does not change target asset allocations while tactical can alter allocations more actively)
• Decide target allocation for each asset in a strategic asset allocation
• Periodically rebalancing portfolios

For a portfolio using strategic asset allocation, with long term target allocation being fixed (and only changed when major events such as approaching to retirement and children college education spending, for example), one can further enhance a portfolio return and reduce the risk by rebalancing and fund selection in an asset class. It is reported that adopting proper timing and way to rebalance a portfolio can improve return and reduce risk (see Daryanani opportunitstic rebalancing article).  In this article, we focus on fund selection.

In a well designed portfolio for retirement plans (401K or IRA), it is a popular practice to have funds with various style exposures. In a stock/equity asset, a fund style is defined as value style (growth/blend/value) and size style (large/mid/small cap). The Morningstar 9 boxes of styles are essentially the combinations of the 3 value and 3 size styles. In a fixed income asset, a fund style is a combination of credit risk (junk/investment grade) and interest rate risk (short/intermediate/long) for corporate bonds or a just interest rate risk for treasury bonds.  In an actively managed portfolio, it is a well recognized and widely practiced method to select funds based on style rotation to improve a portfolio alpha or return. For example, in an article published in Journal of Asset Management (May, 2007), B. Arshanapalli , L. Switzer and K. Panju concluded that active multi-style rotation strategies can be devised to outperform the best performing buy-and-hold portfolio.

MyPlanIQ maintains an index fund based plan or an ETF based plan using candidate funds based on those in a lazy portfolio proposed by Fund Advice Paul Merriman and maintained by MarketWatch.com (called Fund Advice Ultimate Buy and Hold Portfolio) (see here for the independently tracked portfolio on MyPlanIQ.com). The candidate funds and the original allocation are as follows

The funds cover five asset classes: U.S. Equity, International Equity, Emerging Mkt Equity, U.S. REIT and Fixed Income. They have various style exposures for U.S. stock market (equity), International Stocks and Fixed income.

MyPlanIQ Strategic Asset Allocation (SAA) selects funds with the best risk adjusted returns for each asset class when rebalancing.  The following table compares the Strategic Asset Allocation (SAA) moderate portfolios in both index fund and ETF plans as well as the original portfolio (both MyPlanIQ SAA moderate portfolios have 40% allocation in fixed income). We also include the strategic asset allocation moderate portfolio in MyPlanIQ Five Core Asset ETF Plan that consists one fund for each asset class.

As of 7/2/2010

From the above table, we can observe:

• Diversification over styles improves return (FundAdvice Buy and Hold vs. Five Core SAA Moderate).

• Style rotation adds 1.3-1.7% returns over buy and hold (SAA Moderate ETF or Index Funds vs. FundAdvice Buy and Hold).

The above observations are consistent across thousands of plans MyPlanIQ maintains. We should also point out that better fund/style selection does not alter the overall portfolio risk allocation, which is a major advantage over an actively managed tactical asset allocation portfolio.

At the moment, for U.S. stocks, MyPlanIQ SAA favors small cap (IWM), small cap value (IWN). For fixed income, it favors Inflation-protected treasury (TIP).

labels:investments,IRA,401K,

Symbols:vti,spy,veu,efa,vwo,eem,iyr,icf,vnq,dbc,gsg,bnd,agg,tlt,lqd,tip,iwb,oef,iwd,iwo,iwm,ijr,iwn,iwp,iwr,ijh,iws,dvy,iwc,efv,iww,iwv,iwz,VFITX,VFISX,VTRIX,VDMIX,VIPSX,NAESX,VISVX,VIVAX,VFINX,VEIEX,VGSIX,

comments(0)