Three years ago, Vanguard introduced ETF portfolio solutions to Canada with a simple proposition: investors can stay within their specified risk tolerance at low cost, with the rebalancing decisions being left in the hands of a more capable manager. While time hasn’t erased the validity of that argument, the asset-allocation market has grown to address a wider diversity of needs.
“If you look at the balanced portfolios that were used in previous decades and apply them today, you’ll see investors are facing a dilemma in terms of getting lower average returns,” said Prerna Chandak, vice president, ETFs at Mackenzie Investments. “A given target return is likely going to take greater investment risk looking ahead than what we've seen historically.”
Tackling the yield challenge
As Chandak noted, a 60/40 portfolio consisting just of U.S. large-cap stocks and U.S. government debt over the past 40 years would have been able to comfortably earn returns in the neighbourhood of 10%. But that same portfolio today, extrapolated to the next decade, would realistically be expected to fetch 4%. Coupled with the reality of longer lifespans and potentially lengthier retirements, exploring more asset types is more critical today than ever to meet investors’ needs for retirement income and volatility protection.
“Today, you've got a variety of asset-allocation ETFs on offer with different risk profiles to help investors mitigate the impact of market volatility,” Chandak said. “Low cost is a critical element too; while some do include active products in the mix, asset-allocation ETFs tend to be built primarily with index ETFs.”
With such single-ticket solutions serving as the core of a portfolio, investors can devote more of their risk and fee budget to satellite investments. Among DIY investors, that means acting on their interest or conviction in areas such as technology or healthcare; for advisors, it’s more time managing riskier exposures within a client’s portfolio.
“That was a really big driver of increased sales in this category, and I don't think we're going to see a slowdown,” Chandak said, noting that asset-allocation products were among the fastest-growing segments of the Canadian ETF landscape in 2020.
Even in the traditional balanced portfolio, she said there’s room for innovation to pursue greater yield. Within the framework of 60% stocks and 40% bonds, there are products that go beyond domestic exposures to explore U.S. and international markets. In its own asset-allocation suite, Mackenzie offers investors the opportunity to access emerging-market debt, which presents very attractive income and capital appreciation prospects relative to just staying within the North American space.
Avoid investing under the influence
Asset-allocation strategies have also proven their worth in the past year as the COVID-19 pandemic roiled markets. Faced with the S&P 500’s well-chronicled decline of 30% from top to bottom in the first quarter of 2020, countless investors found their patience and ability to adhere to their long-term plans tested to an unprecedented degree.
“You see this emotional roller coaster play out even in investment industry net sales,” Chandak said. “If you look at the past two decades, you'll see that buying spikes when markets are up, and then selling takes over when you're seeing that dip in the market.”
Whether it’s loss aversion or regret aversion, investors are prone to making market-timing mistakes in the face of volatility. Those who sold out during the short bear market straddling March and April last year likely crystallized massive losses; deciding when to re-enter the market would have been a tough call as well. Between the transaction costs, the stress of decision-making, and everything else, a lot of those investors are likely still licking their wounds even as the broader market staged a historically strong comeback to reach all-time highs.
“That discipline of sticking to an investment plan, not getting deterred by the headlines, and just staying the course was an important element in weathering last year’s turbulence,” Chandak said. “When you’re entrusting the rebalancing activity in someone else’s hands, you’re relieving yourself of the emotional and operational burden of rebalancing. That certainly helps reduce the panic you may feel in the moment as an investor.”
An important piece to asset-allocation ETFs’ reassuring quality, she stressed, came from their transparency. Aside from clearly disclosing their holdings, the providers tend to be transparent about their methodology and process of reviewing the asset mix. On top of that, institutions such as banks and large independent managers such as Mackenzie are able to thrive by providing ongoing product support and information.
“With KYP taking a bigger role because of the upcoming client-focused reforms, advisors want to have the comfort of getting answers today,” Chandak said. “They want to know that you as an ETF manager are doing the right thing in the portfolios, and you're keeping them abreast of how you're changing your products and how that might impact investors. We find that partnership with advisors is very important, and that's a core element of our business.”
A solution for all outcomes
Asset-allocation products also lend themselves well to changes that address investors’ evolving needs. As investors and advisors show increased interest in alternative investments, for example, managers who have experience and expertise in using those non-traditional building blocks have the opportunity to offer an alternative portfolio ETF.
“Investors and advisors will still need to understand what different types of alternative exposures and sub-asset classes you’re putting together as a manager. You can’t take that away,” Chandak said. “You still have to educate the marketplace to ensure there's enough comfort around what's inside the allocation ETF.”
ESG is certainly another growth area for asset-allocation ETFs. They won’t necessarily differ much from traditional products in terms of their asset mixes and how they address investors’ differing risk profiles, but they’ll do more work in terms of having a clearly expressed philosophy around the ESG solutions that are incorporated.
And while asset-allocation ETFs are generally defined by their ability to incorporate different asset classes, fixed-income-only asset-allocation ETFs are emerging as a useful solution. Chandak cited the example of MGAB, one of Mackenzie’s more unique investment products, which goes beyond Canadian government, U.S., and international fixed income to include more niche sub-asset classes like floating-rate loans.
“I think over time we'll see more outcome-driven asset-allocation ETFs. It's not just going to be alternatives or ESG. We're going to see a lot more around retirement income, or inflation hedging, or fixed-income-only,” she said. “Portfolio managers are adapting their asset mixes because investors don’t necessarily want a plain set-it-and-forget-it product. The market is evolving.”
This article originally appeared on WP.
