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For more on this topic read James Gruber's article on this 3 ETF portfolio. 

Mark LaMonica: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information in this podcast is general in nature. It does not take into consideration your personal situation, circumstances, or needs.

Shani Jayamanne: Today, we have a guest episode with James Gruber, and James is an assistant editor at Firstlinks and Morningstar.

LaMonica: And prior to that, he covered Asia as a leading fund manager, stock-broking analyst, and journalist. And more recently, he was a portfolio manager for Asian equities at AMP Capital, managing investments in Asia, and China.

Jayamanne: During his time there, the China Fund was ranked number one globally over one and two years during this time.

LaMonica: Which is impressive.

Jayamanne: Very. And to top this all off, he was also a television and radio news journalist at ABC and founded Asia Confidential in 2012.

LaMonica: And now his work focuses on Firstlinks, where he writes insightful articles on markets, products, and investments.

Jayamanne: And one of these articles was a very similar theme to an episode that we've done already, how to build a portfolio with three ETFs.

LaMonica: This also happens to be one of our most popular episodes. But the key to being a good investor is hearing different perspectives and making an informed decision about the approach that is best going to help you reach your financial goals.

Jayamanne: And the premise for James's research and article is John Bogle's two-funds portfolio. He advocated for U.S. investors to have just two funds in their portfolio, a stock market fund and a bond fund.

LaMonica: And the exposure to each would depend on how much risk an investor needed in their portfolio. The advantage of this was a simple portfolio that was low cost, easy to understand, and easy to implement.

Jayamanne: So James has gone ahead and tried to recreate this idea. Simple, low cost, and easy to implement, but for Aussie investors in an Aussie context.

LaMonica: We know that a lot of our investors will be very interested in how this turns out. So we're very excited about this episode and having James on the podcast.

All right. So James, we did a little introduction earlier about you, but it's good to actually be able to talk about yourself. So you want to tell us a little bit about your background? You have a very interesting background. So yeah, tell us a little bit about yourself.

James Gruber: Thanks for having me on. It's actually my birthday today, so I'm very happy to be on.

LaMonica: Wow.

Gruber: It's a good day.

LaMonica: Happy Birthday.

Gruber: Thank you.

LaMonica: I'm sorry that you're at work doing this.

Gruber: True enough. About my background, look, it's a little bit unusual. I started off in journalism as a journalist. Then I worked up to being chief of staff and a producer for television and radio as well. So the 7pm News on the ABC that you see every night, I know you're watching, Mark.

LaMonica: Of course. Of course.

Gruber: I was producing that in Canberra at one stage. Then I went into finance as a bit of a detour. I was an analyst on the sell side, so I worked for a stockbroker in Asia for about five years and then came down here as part of that back to Australia. Went into portfolio management, did a couple of years of that. And then I, well, I've been AWOL probably for about 10 years where I did my own thing. I owned a few businesses and came to Morningstar a little over a year ago. And have been writing and editing for Morningstar as part of Firstlinks and Morningstar since then.

LaMonica: Okay. And one thing you didn't mention is you were also a podcaster.

Gruber: Yes.

LaMonica: So Wealth of Experience. You want to tell us a little bit about Wealth of Experience?

Gruber: Sure. It's on Morningstar every fortnight. We have regular guests from Morningstar in Graham Hand and Peter Warnes who've been in the industry more than I've been alive. And we also have special guests. They are fund managers and industry executives. And we talk about superannuation, retirement, and investing themes as part of that. And yeah, so tune in.

LaMonica: Yeah, no, absolutely. No, it's great. And one interesting thing is, so you work with two people, Graham and Peter Warnes, who are older than you. Do you constantly make fun of them for being older than you?

Gruber: I would never do that. I respect them greatly.

LaMonica: Okay. Well, on our podcast, Shani makes fun of me all the time for being old. So just something for Shani to think about. We wanted to talk today about an article you wrote. And it was a very popular article. And it was you going through the process of trying to, I think, simplify your investing a little bit and pick a three ETF portfolio. So, you used to be a fund manager. I assume that the fund you were running did not have three ETFs in it. So, yeah, I mean, I guess a simplistic portfolio like that, what do you think the advantages are? Since you've been on both sides of the coin, both professionally and now personally trying to simplify things.

Gruber: Yeah, so let's look at complexity. And if you run an institutional portfolio, it is complex. You have potentially anywhere from 50 to 150 stocks in a portfolio, you have analysts and portfolio managers as part of that. You have a whole investment process overlaying it. You do a lot of research into those stocks. You visit managers. You go to different states or countries to do that. You talk to competitors. The process is endless. It's complex. I don't have that time anymore as an individual investor, like a lot of people. And simplifying it has a lot of advantages. You don't have to keep track of everything so much. It can be low cost, less time consuming, obviously. And it can just -- simplification as you get a bit older with life as well as portfolios, I think is better. I think it comes with age a bit. And I'm getting older, Mark.

LaMonica: Okay. And literally older today. So, we talked a little bit about the article before you published it. And you said one of the challenges you had, and maybe this is with your background and the fact that you are so knowledgeable about this stuff, is that literally every ETF you found, you found some sort of problem with it. So, yeah, I mean, I guess talk a little bit about that and how you actually got to the place where you were willing to pull the trigger on something.

Gruber: I'm an overthinker. Well, the premise initially was, look, I had some excess cash that I wanted to put into the market. How best to do that in a simplified way, low cost way. And I thought about a simple ETF portfolio that would cover that off. And how would I go about doing that? And I immediately thought of the legendary Vanguard founder, John Bogle, who advocated that individual investors could get by with a two index fund portfolio. Now, there's a bit of a difference between index funds and ETFs. And we won't go into that here. We'll just talk about ETFs, because they are somewhat similar. But he advocated a U.S. Total Equity ETF and a bond one, a Total Bond ETF. So two ETFs cover the market, both from stocks and bonds. And he was a U.S. based investor. So he was talking about the U.S. to U.S. investors.

Myself being an Australian investor, you could do it simply, as you know, by investing in an ASX 200 or 300 or All Ords Equity Fund ETF. There are numerous ones out there, you could do that. And on the bond side, there's a Total Bond Market ETF as well. So you could cover the Australian market in a similar fashion. If you think through that, though, there are some challenges. Australia's a pretty small market. It's about 2% of the world stocking index. So we're small fry in the global scheme of things. Our index here is also heavily weighted to the likes of banks and mining heavily concentrated. We don't have much tech, large healthcare, industrial, you don't get that in Australia. So do you want some greater world exposure as part of that?

Well, you can. So you could split that potentially with two ETFs on the equity side. You could go Australia and world ex Australia. You could do it that way, you'd have the world covered four stocks as a total stock market portfolio. And that would cover it off nicely. The over thinker in me though, thinks, well, what about that global stock ETF? What does that entail? Because what you've got to think about is with ETFs, there's a title for them, then there's what's actually in them. And they can be quite different. And you've got to investigate that a little bit so you know what you're buying.

With a world stock ETF, a large percentage of that is U.S. It's about 58% is the U.S. market. You're buying a lot of the U.S. as part of that. Are you comfortable with that? Personally, I think the U.S. is a little bit toppy at the moment. That is expensive. I'm not sure if I want that greater exposure to the U.S. So there's a complication there. How do you break that down? Well, you could go to another ETF potentially, you could do Australia, the U.S., and then you could have maybe Europe/emerging markets fund. You could split that up into thirds and you could have three ETFs on the equity side and you would cover the world and it would be relatively simple. The next challenge, if you overthink it like me, on the emerging market side, again, if you look underneath the hood, a lot of it is China.

I've been a China portfolio manager. I think I know it reasonably well. And I don't like investing in China, to be honest. I think its government isn't driven by capitalism and it makes it hard for companies to thrive. And really, the index returns from China have been poor for a long, long time. Well before 2008, if you compare it to the likes of India and other Asian countries surrounding it, they've been astonishingly poor. India has trounced it as well as other markets in the region, in Asia. So do you want such a large China exposure as part of emerging markets is something to think about as well? And funnily enough, a lot of other investors are thinking along the same lines. In the U.S., there are emerging market funds that are coming out ex-China. I think you'll see them soon in Australia because people may not want that kind of China exposure like me.

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LaMonica: I think the China thing is interesting because, and I think people have problems with individual shares or even sectors and thematics like that. People think growth, the economy has grown very quickly in China over the past couple of decades. Growth equals good returns, but that's not necessarily the case.

Gruber: Not at all. The growth has been phenomenal from an economic viewpoint, and there have been some success stories, particularly on the tech side, Tencent, Alibaba and so on. But overall, the market has performed extremely poorly, and it's probably a function of not only being a communist country, but just as an analyst and portfolio manager there. There were sectors that were very difficult to understand because you had government players in there as well as private, and it was very hard to understand how the private guys were going to win out against the government guys at the end of the day. There were regulatory issues, say for instance the healthcare industry there. We know the U.S. healthcare industry is complex. Well, the Chinese one is probably more complex. It is ridiculous, and to get a handle on what kind of companies are going to thrive in that industry is extraordinarily difficult. I've been under the hood of those sectors and companies in China, and that does turn me off.

LaMonica: Yeah. Okay. Well, let's get into some specifics now. Maybe we'll start on the equity side. What did you actually end up choosing and why? You talked a little bit about the thought process, but yeah, where did you land?

Gruber: I landed on the choosing of just simplifying it with Australia and global ex-Australia. I've tried to keep it as simple as possible. I think the more questions you ask yourself and the more you go down that route, the harder it can kind of be. I can totally understand though why potentially you'd want maybe one or two more ETFs as part of that, branch out into Europe and emerging markets a little bit more, but keeping it simple, you cover the world into two ETFs for equities works for me.

LaMonica: What did you think about, because I do get this question a lot in terms of allocation. You talked about that if you were a non-Australian and you were trying to get exposure to the globe, Australia would obviously be very small. Where did you land between allocating between global and Australia? It's probably not going to be 2% as an Australian, but what do you think? What are the considerations about where to go?

Gruber: It's difficult. I went with 30 Australia, 70 world, but it's quite arbitrary why I went with that. I think anywhere for an Australian-based investor, anything from 20 to 50 kind of makes sense. I think more than that, probably less so, but it is arbitrary. The other consideration is on the international side is currency as well. Currency is a factor. Should you hedge that international portfolio? The evidence that I've seen is that the longer your time horizon, and mine is kind of 10 plus years, the less of a factor currency really plays and that you don't really need to hedge it. But if you've got less than 10 years or five or less particularly, then currency is a larger factor. That's something to think about as well.

LaMonica: Yeah, because actually, we were talking earlier about Shani making fun of me for being old. She thinks I have well less than five years to live, so I'll have to consider that in my own investment approach. But let's move over to bonds. When you were working professionally, as an analyst and portfolio manager, you were working with equities. How do you think about bonds and how do you think about them in the portfolio and how do you choose? There are lots of options in bonds as well.

Gruber: There are. I'm an equities guy, self-confessed, and I'm not a bond specialist. But the way I view it is that bonds are a ballast and diversifier for a portfolio. They're really a safeguard for an investor in some way. The reason why 60%, 40%, 60% equities and 40% bond portfolios are popular is because people want to not have the volatility that comes with equities solely in their portfolio. If equities go down by 50% as they did in 2008, then they may not have the stomach for that to hold on. That's really what you want to do. You want to be able to hold on when there is a downturn because usually they're the worst times to sell. And bonds give you that cushion potentially during that time where you will be able to hang on if there's a downturn because if stocks go down 50%, bonds may go down but nowhere near as much. Overall, your portfolio won't go down anywhere near as much as if you had 100% exposure. So that's the way I think about it. I do have a view though that if you're a very long-term investor, and I'm thinking even in a superfund, your own superfund, for instance, it's a default superfund, and I'll probably write about this at some point, but I think it makes a lot of sense to have 100% equities in a superfund if you've got 10 plus years in that fund to go, particularly 20 or 30, then if you can stomach that volatility, then it makes a whole heap of sense to have more equities in there.

LaMonica: Yeah, so I guess two things. You were talking about behavioral risk, right? The volatility induces somebody to do something stupid, sell at the bottom of the market or pile it at the top. Is that a particular fear you have for yourself?

Gruber: I do. Yeah, I'm like everybody else. I do have that fear. I sold out of some things at the bottom of 2008. So there's always that fear, and I'm quite conservative as well by nature. So I need to protect my own worst instincts, so I'm part of that. So I think that in an ETF portfolio like this, that I need to have some kind of weight to bonds, that I need to have something in the order of 30% to 40% makes a fair bit of sense to me as a conservative investor.

LaMonica: Okay, and you were saying that you have over a 10-year time horizon. Do you plan on changing that allocation, at least between equities and bonds, as you get older or you're comfortable with sticking with this?

Gruber: I'm comfortable with sticking with that. You've got funds that specialize in changing allocations as you get older these days.

LaMonica: Oh, there's target funds and everything else.

Gruber: That's exactly right. And that does make sense, but for me, I'm going with what I'm comfortable with at this stage, and I'm sticking to that in the long term. I hope that I'll stick to it.

LaMonica: Yeah, and I think it's a really good point that all of us as investors need something we're comfortable with at the end of the day, right? Something we can stick with because the worst thing is constantly changing your portfolio.

Gruber: So I think that people need to think about those circumstances where things go wrong and what they would do. And the best guidance for that is often the past, how you've acted in the past, have you got nervous, have you panicked, have you done things that were not wise from a present perspective? And you've got to think seriously about that and know yourself and then have a portfolio that reflects yourself, because ultimately it needs to reflect you rather than anybody else.

LaMonica: Yeah, I think that's an interesting point because you talk to, and certainly people that listen to us or read things at Morningstar know at least these behavioral risks and fear and greed, driving people, especially at the tops of markets and the bottoms of market. And I think maybe they know, okay, well, I should not make changes at this point, but particularly for younger investors who haven't been through anything, right, the GFC, and if we sort of throw COVID aside, I mean, to be fair, that would -- lasted like a month and a half. So if we throw COVID aside, a lot of younger investors might sit there and say, okay, well, I can be 100% equities because I know that I wouldn't sell. And it's a little different going through it. When every day you're seeing your portfolio go down and it's being reinforced by all these news stories that capitalism is going to collapse in terms of the GFC, money is not going to come out of the ATM, yeah, it's a little harder to do when that actually happens.

Gruber: Maybe they would need to think outside of investing and their own experiences and life experiences and how they reacted to them. How did they react during COVID and other events that were quite extreme in their own life and potentially how they reacted to that? They need to know their own psychology and that can come outside of investing as well as inside.

LaMonica: Yeah, personally, during COVID and during the GFC, I just increased the amount that I drink. So I don't know if that probably led to poor financial outcome.

Gruber: Direct correlation.

LaMonica: Exactly. So this article came out this year. So I guess what are the next steps in terms of this portfolio and how you're going to maintain it? Are you going to rebalance or I mean, I guess sort of what's your approach going forward?

Gruber: Yeah, look, I intend to add to it over time and try to keep a similar percentage. It is 70-30 at the moment. Whether I back that off later on is up for debate, but I intend to stick to 70-30, 70% equities that is and 30% bonds in three ETFs, two in the equity side and one in the bond. We can discuss the bond one a little bit, but that's the plan is to add to it. And look, I think if the percentages don't get too out of whack, then I'll continue that. But if say they sway to under 65 for equities, then you'd have to start thinking about potentially rebalancing that. And a lot of the research shows that rebalancing does pay off in the longer term. So that's something for further thought.

LaMonica: Okay. And you alluded to it. Let's talk about the bonds for a second because I meant to ask about that. There are all sorts of bonds, right? The fixed interest market is a lot larger than the equity market. There are all sorts of different varieties from high yield to government to corporate, all sorts of different things. What did you settle on in terms of what you want exposure to?

Gruber: Yeah, look, I settled on, and this is going to be a bit contrary to equities, but I settled on an Australian government bond ETF. Why did I settle on that? Well, it's the safest one. It's going to give me the diversification and safety that I want. And so I didn’t go for more risky, but potentially higher rewarding bonds such as your high yield, your corporate, all of that kind of thing where you can go up the risk curve to get more reward. I didn't do that because I don't think that suits my purposes in terms of what bonds can serve in my portfolio. And why didn't I go global? Well, I could have, and I did think about it. There are pluses and minuses on the research for that, and I didn't feel the need for it. But I'm not an expert, and I think that that does require potentially some more research.

LaMonica: Okay, great. And the most important question is, what are your plans for your birthday?

Gruber: What are my plans? Well, I am going to visit my, well, my quasi-boss, my boss, straight after this, and then I'm going to go to dinner. My family's already in the city. My kids are with my wife at work. You've got to love school holidays. They've come to work with her, and we're going out for dinner in the CBD.

LaMonica: All right. Well, that's great. Well, thank you very much for joining, and Happy Birthday.

Gruber: Thank you.

LaMonica: And thank you, everyone, for listening. We really appreciate it. Obviously, we would love any questions or comments in the podcast app or send me an email. My email is in the notes section. Thank you.

For more on this topic read James Gruber's article on this 3 ETF portfolio. 

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)