In a previous article we noted that Variable Annuities have well chosen sub account funds that can lead to a portfolio that can deliver good returns. We now examine the Vanguard Variable Annuity and see how well an ETF clone performs
The Vanguard Variable Annuity consists of 15 funds. These funds enable participants to gain exposure to four major assets: U.S. Equity, Foreign Equity, REITs, and Fixed Income.
As of Dec. 3, 2010, this plan investment choice is rated as above average based on MyPlanIQ Plan Rating methodology that was designed to measure how effective a plan's available investment funds are. It has the following detailed ratings:
Diversification -- Rated as above average (83%)
Fund Quality -- Rated as average (64%)
Portfolio Building -- Rated as above average (75%)
Overall Rating: Above average (74%)
Asset Class | Vanguard | Schwab | Fidelity |
U.S. | 8 | 35 | 13 |
International | 1 | 5 | 5 |
Sector | 0 | 3 | 12 |
Balanced | 1 | 2 | 8 |
Fixed income | 4 | 9 | 7 |
Emerging Markets | 0 | 1 | 3 |
Real estate | 1 | 1 | 1 |
Target Date | 0 | 0 | 7 |
Compared to Schwab and Fidelity ONEQ, the number of fund choices are significantly fewer, leading to greater stress on the fund quality. This has a lower rating than the other two, so we would expect the returns to be lower.
We also note that the Vanguard annuity has additional restrictions. They limit the trading on any one fund to two sell-buy trips in a year. With the smaller number of funds, this could be a significant restriction.
The chart and table below show the historical performance of moderate model portfolios employing strategic (SAA) and tactical asset allocation (TAA) strategies (both provided by MyPlanIQ). For comparison purposes, we also include the moderate model portfolios of a typical 4 asset SIB (Simple Is Better) plan. This SIB plan has the following candidate index funds and their ETF equivalents:
U.S. Equity: SPY or VTI
Foreign Equity: EFA or VEU
REITs: IYR or VNQ or ICF
Fixed Income: AGG or BND
Performance chart (as of Dec. 3, 2010):
Performance table (as of Dec. 3, 2010):
| Portfolio Name | 1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe |
|---|---|---|---|---|---|---|
| Vanguard Variable Annuity Tactical Asset Allocation Moderate | 13% | 91% | 10% | 92% | 12% | 106% |
| Vanguard Variable Annuity Strategic Asset Allocation Moderate | 11% | 120% | 2% | 7% | 4% | 22% |
| Four Core Asset Index Funds REITs Tactical Asset Allocation Moderate | 8% | 62% | 6% | 55% | 9% | 80% |
| Four Core Asset Index Funds REITs Strategic Asset Allocation Moderate | 12% | 94% | 2% | 7% | 5% | 20% |
The annuity performs well against our benchmark -- indicating a good choice of funds.
We are now going to build a clone plan and see how it performs. We will simplify the choice and not duplicate styles.
U.S. Funds
| Style | Fidelity | ETF |
LARGE BLEND | VDEQX VLISX VTSMX | |
LARGE GROWTH | VHCAX VIGAX | |
LARGE VALUE | VEIPX | |
MID-CAP BLEND | VIMSX |
The U.S. 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 | VGTSX |
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.
Real Estate
| Styles | Fidelity | ETF |
REAL ESTATE | VGSIX | 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 |
High Yield Bond | VWEAX | |
Intermediate-Term Bond | VBMFX | BND |
Cash | CASH | CASH |
Short-Term Bond | VFSTX |
The fixed income class is well balanced with good choices and diversification. We match this with ETFs in each style.
We now compare the returns of the two plans using tactical and asset allocation strategies with a moderate risk portfolio.
Performance chart (as of Dec. 7, 2010):
Performance table (as of Dec. 7, 2010):
| Portfolio Name | 1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe |
|---|---|---|---|---|---|---|
| Vanguard Variable Annuity Tactical Asset Allocation Moderate | 13% | 94% | 10% | 93% | 12% | 108% |
| Vanguard Variable Annuity Strategic Asset Allocation Moderate | 11% | 119% | 1% | 6% | 4% | 22% |
| Vanguard-VA-Clone Tactical Asset Allocation Moderate | 7% | 58% | 4% | 45% | 8% | 75% |
| Vanguard-VA-Clone Strategic Asset Allocation Moderate | 11% | 100% | 1% | 4% | 5% | 26% |
The Variable Annuity Portfolios have a clear lead over their ETF clone. While the rating isn't as good as the Schwab or Fidelity products, there are enough funds in the right classes to give good returns.
We have previously noted that fees can be high and this product has some trading restrictions. 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 to allow you to build a plan that enables portfolios that give you good risk-adjusted returns. It is possible to compete with the returns from these funds with a large choice of ETFs, but in the selection we made in this case, the VA came out on top.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
