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Vanguard’s Hip New Asset Allocation ETFs

February 7, 2018 - 6 comments

I used to be a renegade, I used to fool around
But I couldn't take the punishment, and had to settle down
Now I'm playing it real straight, and yes I cut my hair
You might think I'm crazy, but I don't even care
'Cause I can tell what's going on
It's hip to be square

 

– Huey Lewis and the News, “Hip to be Square”

 

While many ETF providers have been frantically fooling around trying to launch the next hot bitcoin or marijuana fund, Vanguard Canada has been playing it oh, so cool. Instead of chasing after the crowd, they’ve recently released a hip new set of game-changers in the form of three asset allocation ETFs:

Not only are these ETFs as simple as they come, their cost and construction are likely to give most robo-advisors a run for their money. Here’s why: Robo-advisors tend to charge around 0.50% each year to invest your cash and rebalance your portfolio. Vanguard is now offering broad market exposure consistent with your goals and risk tolerances and automatic portfolio rebalancing for under 0.10% per year (above their product costs). This new breed of asset allocation ETFs may lead many investors to wonder what the rest of those robo-advisor fees are buying them in comparison.

Shortly after Vanguard released its tidy new trio of ETFs, my inbox began to overflow with emails from DIY investors clamoring for more info. Ask and ye shall receive! Below are my comments and (so you know for sure it’s me), some deeper analyses. Hankering for more straight talk on the subject? My colleague Dan Bortolotti has also written about them at Canadian Couch Potato.

Canadian vs. Global Equities

In all three ETF portfolios, Vanguard has allocated 30% of the equity mix to Canadian stocks, and 70% to global stocks. This is very similar to my model ETF portfolios, which allocate about 33% to Canadian stocks and 67% to global stocks. Over the long term, these small differences should have no more than a minimal impact on returns.

Global Equity Breakdown

Each ETF portfolio has the same global equity weights: 53.7% to U.S. equities, 35.7% to developed ex North America equities, and 10.6% to emerging markets equities (as of December 31, 2017). This is roughly the same global equity allocation as my model ETF portfolios.

The market capitalization for the underlying indices (as of December 31, 2017) also has the exact same weightings. This suggests that Vanguard is not trying to actively manage the global equity allocations, which is arguably a good thing for us passive investors.

Source: Vanguard Canada as of December 31, 2017

Global Equity Market Capitalization as of December 31, 2017

Asset Class Index Market Cap (USD Millions) Market Cap %
U.S. equity CRSP U.S. Total Market Cap Index $27,452,976 53.7%
Developed ex North America equity FTSE Developed All Cap ex North America Index $18,222,191 35.7%
Emerging markets equity FTSE Emerging Markets All Cap China A Inclusion Index $5,406,288 10.6%
Total   $51,081,455 100.0%

Source: CRSP and FTSE Index Fact Sheets as of December 31, 2017

Global Bonds

There is one key construction difference between my model ETF portfolios and the Vanguard asset allocation ETFs. Vanguard’s offerings include an allocation to global bonds (which are hedged back to the Canadian dollar), while my models invest only in Canadian bonds. Whether this will make a material difference in future returns is yet to be seen. I don’t plan to lose sleep over it myself.

Foreign Withholding Taxes

For the developed ex North America equity allocation, I was pleased to see that Vanguard had decided to hold the Vanguard FTSE Developed All Cap ex North America Index ETF (VIU), instead of a combination of the Vanguard FTSE Europe ETF (VGK) and the Vanguard FTSE Pacific ETF (VPL). They had opted for the combo-holding for the Vanguard FTSE Global All Cap ex Canada Index ETF (VXC), but this small holding change for the new funds should slightly increase their tax efficiency; VIU will only be subject to one level of unrecoverable foreign withholding taxes in tax-free and registered accounts.

Back-Testing Bonanza

If you’re curious whether these differences would have had a material impact on past returns, look no further. I’ve compared the past returns of three hypothetical Couch Potato Index Portfolios (which exclude global bonds and have a slightly higher allocation to Canadian stocks) to three Vanguard Index Portfolios. I’ve used FTSE indices for the Canadian stocks, global stocks and Canadian bonds, as well as a Bloomberg Barclays Index (hedged to CAD) for the global bonds.

Spoiler Alert: The returns are almost identical.

 

Conservative Index Portfolio

Asset Allocation: 40% Equities / 60% Fixed Income

Asset Class Index Couch Potato Index Portfolio (40EQ-60FI) Vanguard Index Portfolio (40EQ-60FI)
Canadian Equities FTSE Canada All Cap Index ETF 13% 12%
Global Equities FTSE Global All Cap ex Canada China A Inclusion Index 27% 28%
Canadian Bonds FTSE TMX Canada Universe Bond Index 60% 35.2%
Global Bonds (CAD hedged) Bloomberg Barclays Global Aggregate Bond Index (hedged to CAD) 0% 24.8%
Total   100% 100%

*Portfolios are rebalanced annually.

 

 

Performance: January 1, 2006 to December 31, 2017

Conservative Index Portfolio (40EQ-60FI) 1 Year 3 Years 5 Years 10 Years Since 2006
Couch Potato 6.90% 5.91% 7.52% 5.87% 5.95%
Vanguard 6.99% 5.98% 7.69% 5.86% 5.92%

 

Balanced Index Portfolio

Asset Allocation: 60% Equities / 40% Fixed Income

Asset Class Index Couch Potato Index Portfolio (60EQ-40FI) Vanguard Index Portfolio (60EQ-40FI)
Canadian Equities FTSE Canada All Cap Index ETF 20% 18%
Global Equities FTSE Global All Cap ex Canada China A Inclusion Index 40% 42%
Canadian Bonds FTSE TMX Canada Universe Bond Index 40% 23.5%
Global Bonds (CAD hedged) Bloomberg Barclays Global Aggregate Bond Index (hedged to CAD) 0% 16.5%
Total   100% 100%

*Portfolios are rebalanced annually.

 

 

Performance: January 1, 2006 to December 31, 2017

Balanced Index Portfolio (60EQ-40FI) 1 Year 3 Years 5 Years 10 Years Since 2006
Couch Potato 9.05% 7.55% 9.69% 6.27% 6.50%
Vanguard 9.21% 7.67% 9.91% 6.30% 6.49%

 

Growth Index Portfolio

Asset Allocation: 80% Equities / 20% Fixed Income

Asset Class Index Couch Potato Index Portfolio (80EQ-20FI) Vanguard Index Portfolio (80EQ-20FI)
Canadian Equities FTSE Canada All Cap Index ETF 27% 24%
Global Equities FTSE Global All Cap ex Canada China A Inclusion Index 53% 56%
Canadian Bonds FTSE TMX Canada Universe Bond Index 20% 11.7%
Global Bonds (CAD hedged) Bloomberg Barclays Global Aggregate Bond Index (hedged to CAD) 0% 8.3%
Total   100% 100%

*Portfolios are rebalanced annually.

 

Performance: January 1, 2006 to December 31, 2017

Growth Index Portfolio (80EQ-20FI) 1 Year 3 Years 5 Years 10 Years Since 2006
Couch Potato 11.21% 9.19% 11.85% 6.54% 6.92%
Vanguard 11.43% 9.36% 12.11% 6.61% 6.94%

 

So, once you’re done squinting at the two, nearly identical lines in the charts in the back-tested comparisons above, let me know if I can answer more questions. Otherwise, consider yourself hip to the news on these three new Vanguard asset class ETFs. For me, the take-home is: It’s about time somebody squared away this sort of offering.

By: Justin Bender with 6 comments.
Comments
  16/02/2018 3:29:21 PM
Justin Bender
@John McKibbon: Good catch – I’ll have to update my blog. It looks like the US foreign interest is generally exempt from withholding tax (I calculated a FWT rate of about 3.61% on VBU during the 2017 tax year), but there seems to be a high FWT drag on international bond interest through VBG (I calculated about 16.70% during the 2017 tax year).
 
  14/02/2018 3:05:03 PM
John McKibbin
Justin,
Thank you for your response re: FWT on VBU & VBG - (foreign interest income from VBU and VBG is generally not subject to foreign withholding taxes).
I have reviewed the CDS.ca T3 "Allocations & Designations" spreadsheets for VBU & VBG for 2017.
Using CDS data, I've calculated that VBU has a FWT rate of 15.38 in 2017 & VBG 15.56%?
I reviewed your excellent White Paper on FWT and both VBU & VBG are Canadian-listed ETF that holds a US-listed ETF, so I assume that they subject to both Level I & Level II FWT?
What am I missing?
Thank you, John
 
  13/02/2018 11:21:47 AM
Justin Bender
@Phil: Vanguard will also be periodically rebalancing the portfolios, so this is done for you automatically.
 
  12/02/2018 10:24:44 AM
Justin Bender
@John: I’m not sure what your specific question is. Please refer to our white paper on foreign withholding taxes to learn more (foreign interest income from VBU and VBG is generally not subject to foreign withholding taxes).

https://www.pwlcapital.com/pwl/media/pwl-media/PDF-files/White-Papers/2016-06-17_-Bender-Bortolotti_Foreign_Withholding_Taxes_Hyperlinked.pdf?ext=.pdf
 
  10/02/2018 10:11:20 PM
Phil
Justin, let's say there was a significant drop in the equities market. One of the advantages for investors who used your model ETF portfolios is that they could sell off some of their bond ETFs while they are high and go shopping for equity ETF bargains. How can that be done with these all-in-one ETF funds?
 
  09/02/2018 10:03:44 AM
John
Thank you for this!
You referred to FWT re: VIU used for "developed all-cap ex-NA".
I'm interested in your comments on FWT re: VUN used for "US total-market" & VEE used for "emerging markets all-cap".
Also FWT re: VBU used for "US bond" & VBG used for global ex-US bond".
Thank you, John
 



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