The highest rating that Morningstar Manager Research analysts bestow on ETFs is a Gold Medalist Rating. That means we expect the ETF will outperform other ETFs that invest in similar markets as represented by the Morningstar Category. In non-jargon that means if a passive ETF investing in large-cap US shares receives a gold rating we think it will outperform most other ETFs that invest in US shares.

I’ve summarised our research on 3 Gold Medalist ETFs that invest in different asset classes. For 2 other core asset classes I’ve included Silver and Bronze rated ETFs as Gold Medalist ETFs were not available. This allows an investor to build a diversified portfolio of Australian shares, US shares, global shares and Australian and global fixed interest. The allocations to each ETF are based on an investor’s goals and the associated risk capacity which represents the amount of risk required to achieve desired returns.

This article contains a step-by-step process to establish an investment goal and setting an appropriate risk capacity.

All of these ETFs are passive products which track major indexes. Many investors are gravitating towards passive ETFs as they offer a low-cost and tax efficient way to achieve market returns.

US large-cap shares: iShares S&P 500 ETF (ASX: IVV)

iShares Core S&P 500 ETF earns a Gold Medalist rating and offers well-diversified, market-cap-weighted portfolios of 500 of the largest U.S. stocks. The funds accurately represent the large-cap opportunity set while charging rock-bottom fees, a recipe for success over the long run.

The funds track the flagship S&P 500, which selects 500 of the largest U.S. stocks—roughly 80% of the U.S. equity market—and weights them by market cap. An index committee has discretion over selecting companies that meet certain liquidity and profitability standards.

While a committee-based approach may lack clarity, it adds flexibility to reduce unnecessary changes during reconstitution, taming transaction costs compared with more-rigid rules-based indexes.

The end portfolio is well-diversified and accurately resembles the U.S. large-cap opportunity set. This allows the strategy to capitalize on its low fee, ultimately delivering sound long-term performance on both an absolute and risk-adjusted basis.

The bedrock of this strategy is market-cap weighting, which harnesses the market’s collective wisdom of the relative value of each holding with the added benefit of low turnover and associated trading costs. It’s a sensible approach because the market tends to do a good job pricing large-cap stocks. The companies in this portfolio attract liquidity and widespread investor attention, such that prices reflect new information quickly.

However, when few richly valued companies or sectors power most of the market gains, market-cap weighting may expose the strategy to stock- or sector-level concentration risk, as is the case at year-end 2023. As of December 2023, the top 10 holdings made up the largest portion of the index (30%) in several decades, and the 30% allocation to technology stocks was the highest since the dot-com bubble. But this is not a fault in design, the S&P 500 simply reflects the market composition. In the long run, its broad diversification, low turnover, and low fee outweigh these risks.

Global shares: Vanguard MSCI Intl ETF (ASX: VGS)

Vanguard MSCI Index International Shares ETF earns a Gold Medalist rating and provides Australian investors with an affordable and efficient gateway to the global equity markets. This exchange-traded fund and its AUD-hedged version (ASX: VGAD) mirror the MSCI World ex Australia Index (and AUD Hedged version for the hedged class), incorporating net dividends reinvested, setting a challenging benchmark for active fund managers to surpass. With its low expense ratio and Vanguard's expanding scale, the strategy presents a formidable challenge for active managers to beat.

The underlying index has universal appeal for constructing a diversified portfolio that spans 22 developed economies represented by approximately 1,500 holdings. The index is skewed toward the United States (a common feature across most global indexes) but given the majority of its holdings are multinationals earning sizable revenue from international markets, concentration is not a notable risk here.

The strategy will wax and wane with the index and is chained to its notable biases. Of late, it has faced intense competition from skillful active managers who, with their enhanced risk-management skills, can weather the market volatility better to beat the index.

However, in terms of long-term performance, Vanguard edges past most managers in the cohort. The vehicle may receive currency diversification benefits from investing internationally as the currency is not hedged to AUD, but for those who are currency risk-averse, the AUD-hedged version is also available at a modestly higher price.

In summary, Vanguard MSCI Index International Shares ETF stands out as a best choice for Australian investors seeking global market exposure. Its cost efficiency, broad diversification across multiple developed markets, and solid performance record, especially in a competitive landscape with skilled active managers, highlight its appeal.

Australian bonds: iShares Core Composite Bond ETF (ASX: IAF)

The iShares Australian Bond Index strategy earns a Gold Medalist rating and is an excellent product, suitable to be used as the core building block for one’s fixed-income portfolio. The underlying Bloomberg AusBond Composite 0+ Index is a good representation of the overall opportunity set.

The low fee, especially with the recent cut to the exchange-traded share class, combined with iShares’ proven indexing capabilities only increase its attractiveness.
Portfolio manager Craig Vardy and the supporting team have reliably replicated the underlying benchmark characteristics with a narrow tracking error.

Historically, the fund returns have carried higher sensitivity to interest-rate changes owing to the portfolio’s higher duration relative to the average peer. Duration refers to the amount returns will vary based on interest changes. Bonds move inversely to interest rates with rising rates causing prices to fall and vice versa.

The higher duration can be attributed to the substantial allocation to long-term government and semigovernment bonds, which accounted for more than 90% of the total exposure as of 31 May 2023. The remainder of the portfolio mostly consists of corporate bonds and supranational securities. Thus, credit risk has remained fairly modest.

In general, active managers possess the flexibility to adjust to interest-rate changes, whereas passive investments are bound to the benchmark with minimal control over their risk profile. For instance, the period of rising interest rates through 2021 and 2022 was favourable for active managers to showcase their abilities. However, over the long term, few are able to beat the benchmark consistently.

The fund can functionally play the role of a defensive buffer, damping the volatility of equity investments in one's total portfolio. A high-duration portfolio aided the fund over the sustained decline of interest rates over the past decade. Also, high exposure to government securities in lieu of lower credit exposure enabled it to outperform its peers during stressful periods such as the first quarter of 2020.

We have conviction in the fund's ability to outperform and generate alpha over the Morningstar Category average through longer time horizons. This remains a great investment for investors seeking reliable domestic fixed-interest exposure at a low cost.

Australian shares: VanEck Australian Equal Wt ETF (ASX: MVW)

A Silver Medalist this ETF is a sound choice for diversified Australian equity exposure.

The VanEck Australian Equal Weight ETF is a great option for broad Australian equity exposure. Its affordability and distinctive diversification, achieved through tracking VanEck’s proprietary MVIS Australia Equal Weight Index, underpins its investment appeal.
Our confidence in the strategy's ability to consistently outperform its Morningstar Category benchmark, the S&P/ASX 200 Index, and its peer group average remains steadfast.

The Australian equity market is narrow, where a handful of sectors and industries dominate, including financial services and mining. As such, diversification is crucial. MVW seeks to achieve this by constructing a portfolio where 80 securities are equally weighted.

We view this as a sensible approach to achieve diversification in the top-heavy Australian share market. The exchange-traded fund fully replicates VanEck’s proprietary MVIS Australia Equal Weight Index, which effectively overweights mid-cap companies at the expense of large-cap stocks relative to the broad market index.

The average market cap of the portfolio is less than half that of traditional unconstrained market-cap-weighted products. Consequently, the ETF has an elevated risk profile compared to its market-cap-weighted index ETF peers.

Besides reducing large single-stock exposures, the equal-weight approach also fosters a more-balanced sector allocation (typically, unconstrained domestic market-cap indexes are skewed toward financials and materials). Yet, the ETF still has around 55% of its assets exposed to cyclical sectors, implying its high correlation to domestic economic conditions. In addition, sensitive sectors like energy are structurally overweight, which further adds to the performance cyclicality. However, on balance, the positives outweigh the negatives, especially the attractive price at which the product is offered.

At 0.35% annually, it may be more expensive than other passive options but still much cheaper than the average active manager. MVW benefits investors with its tightly controlled bid/ask spreads as well, which have come down over the trailing two years and are currently averaging 11 basis points per month.

In conclusion, the VanEck Australian Equal Weight ETF continues to present a compelling option for diversified Australian equity exposure aided by its strong index construction and appealing risk-adjusted characteristics.

Global fixed interest: Vanguard Global Aggregate Bd Hdg ETF (ASX: VBND)

The global multisector nature of this Bronze Medalist rated ETF can make it work as the central fixed-income element in a portfolio. The strategy tracks an index with returns hedged to multiple currencies. The low ongoing charges levied by all share classes is a strong point in its favor.

The fund offers significantly lower exposure to China than its passive competitors. This is because Vanguard made an active decision to slow down and eventually stop the process of inclusion of Chinese onshore debt approved by Bloomberg back in 2019.

Vanguard argues that there remain issues that prevent access to China and specifically points to the ability to efficiently handle the hedging of CNY exposure. Other passive fund providers do not share this view and report no difficulty in transacting Chinese assets.

This has translated into a significant divergence in China exposure between this fund and competitors tracking the standard Bloomberg Global Aggregate Bond Index. As of this review, the difference stands at around 9% to 1%. This can work for or against this strategy depending on the performance of Chinese bonds.

Irrespective of differences in China exposure, the trade-off of adopting a passive approach to global bond exposure is the lack of flexibility in country, sector, and duration calls relative to active funds, which can substantially alter the portfolio distribution. This can also increase the chances of making mistakes over the long term, particularly in relation to the credit bucket. The steady approach of an index fund may help to iron these out; not least considering the substantial price advantage. But overall, an index-tracking approach to the global aggregate bond market remains something of a blunt investment proposal. It is good enough for earning the index return but leaves room to add value.

Overall, this index strategy has points in its favor, most notably its low fees. Investors seeking a well-managed one-stop-shop fund for broad global bond market exposure and specifically eyeing limited exposure to China should find that this fund fits the bill.

Final thoughts

You may notice some major asset classes are missing. Namely Australian shares and Global bonds. There are no passive ETFs that receive a Gold Medalist rating for these asset classes.

That doesn’t mean that our analysts don’t believe there aren’t good options for investors.
For more on exposure to these asset classes see the following:

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