ETFs: Revolutionising portfolio construction


The first step to building a robust investment portfolio is determining the right asset allocation. It was determined in 1986 in the Financial Analysts Journal1 that asset allocation was responsible for more than 90% of a diversified portfolio's return pattern over time. In other words, if we concentrate efforts on getting asset allocation correct, a portfolio has the greatest chance of success. In today's investing landscape with so many products and services on offer factors such as cost, transparency and simplicity are also of great importance when making investment decisions. All of these factors are supporting the growth of model portfolios comprised entirely of exchange traded funds (ETFs).

Choosing the right investing risk/return profile is paramount for determining the right asset allocation. A good mix of asset classes (such as Australian equities, international equities, cash, fixed income and property) will - over the long run - help to yield a positive return at lower risk than the individual investments themselves. The process of setting a long term portfolio strategy is called Strategic Asset Allocation or "SAA". SAA involves setting target allocations for various asset classes for the long term and rebalancing the portfolio back to the target allocations periodically when the allocations change due to market movements.

Academics and researchers since Brinson, Hood and Beebower1 over 30 years ago, have demonstrated that the SAA decision is responsible for 90% of portfolio movements and is the primary driver of returns in a diversified portfolio.2 The remaining 10% comes from security selection and market-timing.

A sound investment portfolio usually begins with identifying investment goals and objectives within acceptable levels of risk. An investor's investment approach depends on what they want to achieve such as investing for growth or for income; diversifying an existing portfolio or investing through different risk profiles.

An investors' risk tolerance profile is based on many factors such as age, income, investable assets and knowledge of investments. ASIC's MoneySmart website outlines the typical investment characteristics of four risk profiles - growth, balanced, conservative and cash.

Equally important to the success of an investment portfolio today are the costs investors incur relative to performance. Over the past decade, the investment industry has experienced a rapidly changing environment with turbulent markets, changes in regulation and evolving technology. As a result, clients are scrutinising their investments more closely in search of performance, value and transparency in an increasingly cost conscious world.

The changing of the investment landscape correlates directly with the underperformance of the global active management industry. The S&P Dow Jones SPIVA US Scorecard for the 2016 calendar year found 66 per cent of large-cap managers, 89 per cent of mid-cap managers and 85 per cent of small-cap managers underperformed the S&P 500, the S&P MidCap 400 and the S&P SmallCap 600 respectively. In Australia, active managers didn't fare much better with the majority of active managers underperforming their respective benchmark across all asset classes.

Investors are now aware that underperformance and high costs for active funds compound over time so they aren't just losing the fees and underperformance - they are also losing all the growth that money might have had for years into the future.

As a result, advisers are increasingly switching from active strategies to passive strategies such as ETFs and this is also revolutionising how advisers construct portfolios.

ETF Model Portfolios

The range of ETFs has exploded in recent years resulting in over 12,7503 listings globally including over 200 different ETFs available on the ASX. Australian investors can now get diversified exposure to entire asset classes via a single trade on the ASX. The proliferation of ETF offerings has also led to the emergence of portfolios that are comprised entirely of ETFs.

ETFs are ideal building blocks for an investment portfolio because they offer liquid, diversified and cost effective exposure to many different asset classes and markets. Investors, particularly self-managed super fund investors (SMSFs), are increasingly demanding that investment portfolios provide better diversification at lower cost. ETFs address these issues, while also delivering transparency, liquidity and simplicity of use.

With the increasing sophistication of the ETF industry, particularly the growth of smart beta ETFs on ASX, it is likely that building investment portfolios using entirely ETFs will become more prevalent.

Contact your adviser to learn more about VanEck ETF Model Portfolios.



IMPORTANT NOTICE:Issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck'). This is general information only and not financial advice. It does not take into account any person's individual objectives, financial situation or needs. Before making an investment decision, you should read the relevant PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. PDSs are available at or by calling 1300 68 38 37.

No member of VanEck group of companies gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance, or any particular rate of return of any VanEck funds. Past performance is not a reliable indicator of future performance.

1 In 1986[1] article Determinants of Portfolio Performance, Brinson et al

2 Wallick, Daniel W., Julieann Shanahan, Christos Tasopoulos, and Joanne Yoon, 2012. The Global Case for Strategic Asset Allocation, The Vanguard Group

3 ETFGI media release - ETFs/ETPs listed globally gathered record inflows of US$66 billion and assets reached a new high of US$3.913 trillion at the end of Q1 2017.

Published: 09 August 2018