Complex Simplicity: A Better Portfolio of ETFs

There's been a quote from Ron Lieber (not the actor) in a NY Times article making the rounds that I think is very constructive.

He says: Index (mostly). Save a ton. Reallocate infrequently.

So this got me to thinking a little bit about constructing a portfolio with ETFs. While I think is far from lazy, it does not require stock picking, country picking or selecting style. The mix for the most part includes newer funds or funds that don't seem to get a lot of attention. No percentages as we think this is a no-no for the blog.

Domestic Large Cap

Claymore Ocean Tomo Patent ETF (OTP) TTM it beat SPX by 7% with a touch higher yield.

Developed Foreign Large Cap

PowerShares DWA Developed Market Technical Leaders (PIZ). It beat iShares MSCI EAFE (EFA) by 7% since inception which appears to be in January

Domestic Small Cap

First Trust Small Cap Core AlphaDEX (FYX) TTM lagged ishares Russell 2000 Index (IWM) by 3%.

Developed Foreign Small Cap

iShares MSCI EAFE Small Cap (SCZ) about even with IWM since inception in December.

Emerging Market Large Cap

WT Emerging Market High Yield (DEM) beaten iShares MSCI Emerging Markets Index (EEM) by roughly 5% since inception in July.

Emerging Market Small Cap

SPDR S&P Emerging Market Small Cap (EWX); this fund just listed, so no performance info.

Domestic REIT

Vanguard REIT ETF (VNQ) has had a slightly better TTM than iShares REIT Fund (IYR)

Foreign REIT

iShares Global Real Estate Ex-US (IFGL) has lagged the much larger SPDR DJ Wilshire International Real Estate ETF (RWX) since inception..

Broad-Based Commodity

Rogers Intl Commodity ETN (RJI) beat Barclays iPath DJ ETN (DJP) by roughly 5% since October.

Currency

PowerShares Dollar Bearish Fund (UDN): US dollar hedge without picking a country.

Intermediate Treasury

SPDR Intermediate Term Treasury ETF (ITE) actually looks inferior to the seemingly similar but much larger iShares 7-10 year (IEF)

High Yield Debt

SPDR High Yield Bond ETF (JNK) stands up very well versus PowerShares High-Yield Corporate Bond Portfolio (PHB) and HUG since its very recent inception

Inflation Bonds

SPDR Barclays Capital TIPS ETF (IPE)- the lesser known product.

Emerging Market Fixed Income

iShares Emerging Market Bond Fund (EMB) - one fund in a category of two.

I'm sure there are a couple of segments I forgot (I chose not to include mid-cap but there are quite few choices for domestic, a few for foreign developed, but I don't think any for emerging).

The mix seems like it has too much going on to be lazy, but if any proponents of lazy portfolios want to weigh in, please do.

Lately there has been a theme going around (both here and elsewhere) about whether US markets will provide enough returns for financial plans to work. Depending on how something like the list above was implemented I think it could go a long way toward mitigating the consequence of 6% average annual returns in the US, but probably not do much for people looking to reduce volatility.

That point makes for a good side tangent that if you do allocate more to developed, emerging and frontier, you may increase your volatility longer term. It might be what you need to do depending on where you are in relation to your number ...j ust something to keep in mind.

A generic mix like this provides the 30,000 foot exposure but I think giving up sector and country selection, although these things can be difficult to get right, puts the portfolio at a disadvantage in my opinion. Underweighting financials for the last year or so versus domestic indexes and underweighting Japan versus foreign indexes for the last 18 years were not that impossible to do but should have added value for anyone who did it.

The intellectual debate over this is always interesting. The comments from readers saying stock picking and sector picking in not ideal for most people is valid, my comments saying it is not as black box as some would have you believe are also valid and there can never be one right answer only what is right for you.

Comments

[User 184032:]

regarding indexing, why not try the vanguard index funds, they are generally lower fees, and without the commissions. though it is harder to time the lows to get in, you can buy a few times with smaller size. the other point is about sector allocation, on the top of large-small domestic-foreign allocations. in a market like this, it is useful to get some energy exposures (eg. xle), financial (xlf) or even drugs (eg. xlv).

2008 May 23 09:11 PM

[J. Fredrickson:]

I often find that most people( i.e. those not involved in the financial world) construct portfolios similar to the one above. The thought process I will assume goes something like this, "if I have exposure to just about everything I will not be hurt bad if I am wrong,and have a little skin in the game if an area gets hot, i.e. I will be diversified." It reminds me of putting a little money on every number on the roulette table knowing that you will at least win something.

Most schools (mine included) teach us that diversification is the answer to doing well in the market and that the markets are efficient. I have read the research/books on the topic as well as experienced quite a few years trading and think that it cannot be further from the truth. The reason behind the decision to teach diversification in our institutions has to do with being able to get theories published and needing certain aspects of the research to be constant. Enter efficient market, duh, duh, duh, problem solved, thanks Malkiel, high five (slap!).

But I feel that this strategy leads to mediocre returns. Of course the allocation will very based on many factors, but I feel that it is important for managers and individuals to understand what is happening or going to happen and set-up a strategy to take advantage of the opportunities out there. These do not really provide that incentive. I think that these types of portfolios are lazy, bloated and often times full of "evergreen income" for those lucky managers that get the naive client.

2008 May 23 09:49 PM

[rainman:]

My simple and easy recommendations will be:
a FXI, FXP mixed to bet on China domestic demand to be triggered after the earth quake with a few individual picks such as CEO, and CHA.

2008 May 24 05:28 AM

[rainman:]

forget US market for a while, before consensus reached on inflation.

2008 May 24 05:29 AM

[Boubou:]

Diversication makes sure of three things;-

1) Probably gains and losses should cancel out except when the entire market is rising.
2) Whatever happens you should'nt be wiped out, so that
3) money managers can carry on leeching you out.

2008 May 24 09:35 AM

[Argent:]

Boubou, above, says it all!

2008 May 24 10:40 AM

[R. Richard ...:]

Compare the terms (limits on getting out and getting back in) of Vanguard's VEIEX and its ETF VWO. Then look at respective results in markets price trends.

Long: VWO

2008 May 24 11:12 AM

[David Jackson:]

I just added the link to the NY Times article, which we dropped by accident. (Apologies to Roger and readers.)

Roger -- great article. I love the idea of suggesting alternative ETFs to those most popularly used. But how valid is selection based mainly on recent past performance?

2008 May 24 06:30 PM

[Roger Nusbaum:]

David, The point was not pick this fund because it has done better over the last however many months it was more along the lines of better mousetraps exist than the biggest and often first to market in a space. You want REIT exposure--look under the hood at all (or as many as you can) of them and pick the one you think will be the best. Further if something is near and dear (like water as an example) if you have exposure, ok but when something new comes check it out, maybe its better.

Bigger macro; think about all the choices available b4 you go in.

2008 May 24 08:09 PM

[David Jackson:]

Roger, I think you're totally right. There are a lot of portfolios out there containing ETFs that aren't the cheapest or best, because they were first to market.

2008 May 25 02:14 AM

[Blair:]

I think that the performance history of many of the ETFs mentioned is way too short to make any kind of quantitative assessment as to relative performance comparisons.

My assessment is to wait another year before making any investment decisions as to ETF selections..

2008 May 25 03:12 AM

[Roger Nusbaum:]

Blair no argument, for you it might be a year, someone else six months--no wrong answer. The context is the attempt to teach how to fish not to hand mackerel out from the back of a truck:-)

2008 May 25 09:17 AM

[Thomas Smic...:]

Good job, Roger. Information an investor can use!

2008 May 26 12:07 AM