How to use ready-made ETF portfolios

Whether or not investors enjoy creating and managing their own ETF portfolios, ready-made portfolios and funds of ETFs and index funds offer a convenient alternative.

This is the ninth in a series of articles by Henry Cobbe, head of research at Elston Consulting, exploring the world of index investing. Henry is author of “How to Invest With Exchange-Traded Funds.

Who needs or wants a ready-made portfolio?

Individual investors of all wealth levels may find the prospect of engaging with their investments daunting, time-consuming, or both.

This is heightened by the high number of investment products and services that are available. In the UK, there are more than 70 discretionary management firms and more than 3,000 investment funds and ETFs.

For this reason, DIY investors may want ready-made portfolios that are an easy to buy and easy to own. Not only do these solutions seem like a simple alternative, they can also address and can potentially mitigate behavioural mistakes. 

Below, I consider in more detail three alternative ways of delivering ready-made portfolios for DIY investors, including multi-asset funds, ETF portfolios and multi-asset ETFs.

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Multi-asset funds

Multi-asset funds (also known as asset allocation funds or multi-manager funds) are the most established type of ready-made portfolios. By owning a single fund (or in some cases an investment trust), investors get exposure to a diversified portfolio of underlying funds to reflect a specific asset allocation. Having selected a strategy, the investor does not need to worry about the portfolio construction to achieve that asset allocation or about security selection within each asset class exposure.

We categorise multi-asset funds into different categories by investment strategy:

• Managed balanced funds are the “original” multi-asset funds and represent an unfixed asset allocation between equities and bonds that the fund manager will adapt based on their view of the markets. These funds may hold direct equities and bonds or use equity and bond funds that are typically actively managed.
• Relative risk funds (also known as risk-profiled funds) target a risk (volatility) that is relative to equity risk and are designed for a group of investors who share a risk-return objective.
• Target risk funds target a risk (volatility) band in absolute terms.
• Target date funds target a date in the future when withdrawals are expected to commence and are designed for a group of investors that share a time-based objective.
• Target absolute return funds target a return objective and are unconstrained in their investment approach.

Multi-asset fund types summarised

Source: Elston, for illustration only.

Despite the cost of wrapping underlying funds within a fund structure, economies of scale mean that multi-asset funds can be delivered to investors at highly competitive prices with very low minimum investment requirements. However, the disadvantage is that multi-asset funds have a one-size-fits-all approach that means there is little scope for customisation to individual needs.

ETF portfolios

ETF portfolios are a basket of individual ETFs providing an asset allocation. Rather than wrapping an investment strategy within a fund, a model portfolio is made available as a basket of ETFs that can be bought individually to create the strategy. Model portfolios may be “strategic” (rebalanced to fixed weights of the same securities) or “tactical” (rebalanced to changing weights of the same or different ETFs). Model portfolios are research portfolios meaning that the model portfolio provider has no control of client assets so it is up to a portfolio manager, adviser or DIY investor to implement any changes should they wish to follow a given model portfolio strategy.

The advantages of ETF portfolios include:

• Potentially lower fees owing to the removal of a fund wrapper to hold the strategy.
• Greater flexibility and specificity with regards to asset allocation design.
• Agility as strategies can be launched or closed with ease.

An example of an ETF portfolio could be as simple as a classic global 60/40 equity/bond strategy constructed with ETFs.

Example of a simple ETF Portfolio

While ostensibly very simple – a two-security portfolio – the underlying holdings of each ETF means that investors get exposure to 3,133 equities in global and developed markets (approximately 47 countries) and 1,660 investment grade bonds in more than 24 countries. Put simply, the investor is able to buy the bulk of the global equity and bond markets with two simple trades.

When managers, advisers or research firms create model portfolios, the weighting scheme can be one of three types as summarised in the table below.

Types of ETF portfolio weighting scheme

Source: Elston, for illustration only

The ability to design and create ETF portfolios with an increasing number of ETF building blocks means that both traditional (asset managers, stock brokers) and non-traditional providers (trade publications, investment clubs, industry experts) can create investment strategies that can be “followed” by investors. However, the usual due diligence rules for any investment provider should be applied.

While the rise of more bespoke ETF strategies is welcome, the convenience of having a single strategy delivered as a single security from a portfolio construction perspective is attractive. This is where multi-asset ETFs could have a role to play.

Multi-asset ETFs

Multi-asset ETFs are an emerging way of delivering the returns of a managed ETF portfolio using a single instrument. Whereas multi-asset funds are often funds of index-tracking funds, multi-asset ETFs can be viewed as an “ETF of ETFs”.

In the US, there are a number of multi-asset ETFs available providing a ready-made allocation within a single trade. However, we expect multi-asset funds, constructed with ETFs and index funds, to gain more traction than multi-asset ETFs.

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Multi-asset funds (constructed with index funds/ETFs), ETF portfolios, and multi-asset ETFs provide a ready-made one-stop for delivering a multi-asset investment strategy for all or part of an investment portfolio, whether defined by a multi-asset index or not.

The advantages of a multi-asset fund of ETFs as a ready-made portfolio

The advantages of a “one-and-done” approach include collectivisation, convenience and consistency.

The collectivisation of investor objectives creates cost efficiency from economies of scale. Adopting a collectivised approach can be undertaken where each group of clients shares the same goal (as defined by, for example, a target risk level or income objective, or volatility objective or target date).

This can help achieve economies of scale and lower the cost of offering professionally managed asset allocations in at least three different ways.

First, each cohort becomes a multi-million pound “client” of an asset manager that can deploy institutional-type bargaining power on the pricing of the underlying funds within their asset allocation. 

Second, the collective scale reduces frictional trading costs of implementing the asset-allocation decisions: one managed investment journey is more efficient to manage and deliver than thousands of individual ones. 

Third, there’s convenience. Rather than focusing solely on building optimal multi-asset class portfolios that need monitoring, the proposition of investment offerings can be engineered to eliminate poor behavioural tendencies that prevent effective management. Engineering funds to offer a single investment journey that investors do not necessarily need to monitor regularly in order to reach their goals can help reduce the perceived hassle of investing.  

It can also motivate individuals to invest. Professionally managed funds prevent investors from either not rebalancing the portfolio, or doing it in an improper fashion owing to behavioural tendencies such as status quo bias and disposition effect.

Furthermore, a professionally managed strategy can respond when it comes to other areas of concern such as shortfall, concentration or longevity risks, which lay investors can overlook. An additional advantage of managed diversified funds is curtailment of the number of products offered, thereby reducing the cognitive load of making an investment decision and preventing decision deferral. 

There is also increased consistency. Investors in each strategy experience the same time-weighted investment returns, thereby reducing the likely dispersion of returns that a group of investors would experience through an entirely self-directed approach. This consistency is why multi-asset funds have also been adopted by some financial advisers as a core or complete holding within a centralised investment proposition.

The disadvantage of a ready-made portfolio is not a secret. They are designed as a “one-size-fits-all” product with no scope for customisation.

The respective features of the various types of ready-made portfolio are set out below. Whereas multi-asset funds of ETFs, and multi-asset ETFs can be accessed via a single trade, their scope for customisation is low. ETF portfolios have the highest degree of flexibility for creating custom strategies, but are not accessible via a single trade.

Comparing ready-made portfolios

Summary

Ready-made portfolios are easy to buy and own. They enable a “set and forget” approach to investment management, which can help design out key behavioural risks, or provide a useful core holding for a broader strategy.

Obviously the primary choice is which strategy an investor opts for, or their adviser recommends depending on their risk-return objectives and suitability.