Vanguard VA Has Some Rules and Can Be Cloned with an ETF Portfolio

12/08/2010 Share 0 comments

In a previous article noted that Variable Annuities have well chosen sub account funds that can lead to a portfolio that can deliver good returns. We now examine the Vanguard Variable Annuity and see how well an ETF clone performs

The Vanguard Variable Annuity consists of 15 funds. These funds enable participants to gain exposure to 4 major assets: US Equity, Foreign Equity, REITs, Fixed Income.

As of Dec 3, 2010, this plan investment choice is rated as above average based on MyPlanIQ Plan Rating methodology that was designed to measure how effective a plan's available investment funds are . It has the following detailed ratings:

Diversification -- Rated as above average (83%) 
Fund Quality -- Rated as average (64%) 
Portfolio Building -- Rated as above average (75%) 
Overall Rating: above average (74%)

Compared to Schwab and Fidelity, the number of fund choices are significantly fewer leading to greater stress on the fund quality. This has a lower rating than the other two and so we would expect the returns to be lower.

We also note that the Vanguard annuity has additional restrictions. They limit the trading on any one fund to two sell-buy trips in a year. With the smaller number of funds, this could be a significant restriction.

The chart and table below show the historical performance of moderate model portfolios employing strategic and tactical asset allocation strategies ( SAA andTAA , both provided by MyPlanIQ). For comparison purpose, we also include the moderate model portfolios of a typical 4 asset SIB (Simpler Is Better) plan . This SIB plan has the following candidate index funds and their ETFs equivalent:

US Equity: SPY or VTI
Foreign Equity: EFA or VEU 
REITs: IYR or VNQ or ICF
Fixed Income: AGG or BND

Performance chart (as of Dec 3, 2010)

Performance table (as of Dec 3, 2010)

The annuity performs well against our benchmark -- indicating a good choice of funds

We are now going to build a clone plan and see how it performs. We will simplify the choice and not duplicate styles.

US Funds

The US funds choice is very wide. There are probably too many choices in this category and it would be better to have more choices in other asset classes.

We will not mirror all the choices with the ETF clone just one ETF in each style category.

International Funds

It would have been better to have some mid or small cap alternatives but still a good amount of choice.

We will match one style in each category in the international asset class.


Real Estate

Real estate is under represented -- an international REIT would strengthen this asset class.

We add an international REIT Fund to the ETF's.

Fixed Income

The fixed income class is well balanced with good choices and diversification.

We match this with the exception of having a second intermediate term bond. We add an emerging markets bond to offset this.

 We now compare the returns of the two plans using tactical and asset allocation strategies with a moderate risk portfolio.

The Variable Annuity Portfolios have a clear lead over its ETF clone. The reason for this is the larger number of funds to allow styles rotation. One important note is that the returns are before fees are assessed. Variable annuities are complex instruments with fees that can be in excess of 2% of the asset base per year. Even so, the historical returns are good and there is the benefit that gains are not taxed.

Looking at the fund design for Variable Annuities can be instructive to allow you to build a plan that enables portfolios that give you good risk adjusted returns.

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