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

The Schwab Select Annuity Annuity's plan consists of 56 funds. These funds enable participants to gain exposure to 5 major assets: US Equity, Foreign Equity, REITs, Emerging Market Equity and Fixed Income.

As of November 26, 2010, this plan investment choice is rated as above average based on MyPlanIQ Plan Rating methodology, which was designed to measure how effective a plan's available investment funds are. It has the following detailed ratings:

  • Diversification -- Rated as great (90%)
  • Fund Quality -- Rated as average (55%)
  • Portfolio Building -- Rated as great (99%)
  • Overall Rating: above average (83%)

Asset Class

Schwab

Fidelity

US

35

13

International

5

5

Sector

3

12

Balanced

2

8

Fixed income

9

7

Emerging Markets

1

3

Real estate

1

1

Target Date

0

7

We note minor differences in fund choices between the Schwab and Fidelity offerings. We would expect the performance to be similar. The reason for the difference in performance is the quality of the funds.

click to enlarge images

Performance chart (as of November 30, 2010):

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:

Style Fidelity ETF

LARGE BLEND

DGAGX

KBCAX

PIODX

PJIAX

SICWX

SWHGX

SWPPX

VTI

LARGE GROWTH

AAGOX

JGIIX

NMTBX

SDGAX

VUG

LARGE VALUE

ACGMX

ACSDX

AVLIX

KDCAX

MEIIX

VTV

MID-CAP BLEND

GMCBX

GTAVX

RMVSX

SOPVX

VO

Mid-Cap Growth

AMGOX

BGRFX

DFCIX

TEGAX

IJK

Mid-Cap Growth

FMCCX

IJK

MID-CAP VALUE

ABASX

AVUA

IPVIX

IJJ

SMALL BLEND

KDSAX

SMEIX

VB

Small Growth PGOFX

SIGWX

SSDAX

VBK
Small Value CSSBX

DEVLX

FBVAX

VBR

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:

Style Fidelity ETF

Foreign Large Growth

AIEVX

AWPAX

ABIAX

EFA

World Stock

JWGRX

OGLYX

VT

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.

Emerging Markets:

Style Fidelity ETF

Emerging Markets

LZEMX

EEM, VWO

Emerging markets is under represented here as it is an important class.

We select two emerging market ETFs to provide an alternative style.

Real Estate:

Styles Fidelity ETF

REAL ESTATE

IYR

IYR, RWX

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

We add an international REIT Fund to the ETFs.

Fixed Income:

Style Fidelity ETF

Emerging Markets Bond

EMB

High Yield Bond

PHYAX

HYG

Inflation-Protected Bond

PRRIX

TIP

Intermediate-Govt Bond

FUSBX

SIBWX

BND

Intermediate-Term Bond

PTTRX

JAFLX

Cash

CASH

CASH

Short-Term Bond

PLDAX

SHY

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.

Performance chart (as of November 26, 2010):

Performance table (as of November 26, 2010):

Portfolio Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Schwab Select Annuity Tactical Asset Allocation Moderate 13% 103% 12% 122% 14% 124%
Schwab Select Annuity Strategic Asset Allocation Moderate 13% 136% 4% 27% 7% 42%
Schwab-VA-Clone Tactical Asset Allocation Moderate 8% 56% 5% 42% 10% 72%
Schwab-VA-Clone Strategic Asset Allocation Moderate 11% 91% -0% -5% 5% 22%

The Variable Annuity portfolios have a clear lead over their ETF clones. 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 in allowing you to build a plan that enables portfolios which give you good risk adjusted returns.

Disclosure: No positions

Source: ETF Cloning of Schwab Variable Annuities