Investing basics: how to build a simple, diversified portfolio with listed products
Morningstar senior manager research analyst Matt Wilkinson clears a path to building simple, multi-asset portfolios.
Mentioned: BetaShares Western Asset Aus Bd ETF (BNDS), BetaShares Aus High Interest Cash ETF (AAA), Aberdeen Australia Equity Fund Inc (), iShares Core Global Corp Bd AUDH ETF (IHCB), iShares Core S&P/ASX 200 ETF (IOZ), iShares S&P/ASX Small Ordinaries ETF (ISO), VanEck Australian Equal Wt ETF (MVW), BetaShares FTSE RAFI Australia 200 ETF (QOZ), SPDR® S&P/ASX 200 ETF (STW), Vanguard Australian Fixed Interest ETF (VAF), Vanguard Australian Property Secs ETF (VAP), Vanguard Australian Shares ETF (VAS), Vanguard Intl Credit Secs (Hdg) ETF (VCF), Vanguard Intl Fxd Intr (Hdg) ETF (VIF)
A golden sunset. A perfectly grilled steak. Scratching an itch.
The simple things in life can spark joy. And a simple investment portfolio can bring great profits.
Choosing investments doesn't have to be complicated.
Today, there are over 300 listed products on the ASX including passive exchange-traded funds, active-exchange traded funds, or exchange-traded managed funds and listed investment companies.
These products give you instant access to a professionally managed portfolio of asset classes and markets like stocks, bonds, property and emerging markets.
So how can we use these listed products to our advantage to build simple, low-cost (at times), diversified multi-asset portfolios?
Speaking at the Morningstar Individual Investor Conference earlier this month, Morningstar senior manager research analyst Matt Wilkinson outlined three steps to building simple, multi-asset portfolios, and shared which listed products Morningstar analysts like the most.
Why use listed products?
- Ease of access via the exchange
- Great active and passive products, variety across asset classes
- Can be done cheaply
- Price transparency (gone are the days of putting in a n order for a fund and waiting days to work out what price you got)
- Flexibility and choice – choose simplicity or greater sophistication
Step 1: Establish your asset allocation (bucket method)
Investors must determine their allocation to growth assets and defensive assets. Or to put it simply – how much of your portfolio do you want to be low or high risk?
- Growth assets are a type of investment that tends to carry high levels of risk, but also carry the potential for higher returns over time. These includes assets such as Australian shares, international shares, property and infrastructure.
- Defensive assets are the opposite. They tend to carry lower levels of risk, but typically lower returns. These include assets such as government bonds, corporate credit and cash.
To determine your allocation, Wilkinson says you must consider two questions:
- How long to you expect to hold your investment after you buy it?
- What is your tolerance to risk?
For example, if I know I want to sell my investments and buy a home with the proceeds when I turn 40, then my time horizon in 10 years (give or take a couple months). The longer you have to invest, the more growth assets you can typically have in the portfolio.
When it comes to risk, Wilkinson says they are several online surveys investors can take to help them realise their tolerance to risk. The quality is, however, mixed. The best thing to do, he says, is consider the smoothest return profile you can get by building diversified portfolios with multiple asset classes.
A balanced portfolio – 50/50 defensive and growth assets – typically has a 5- to 7-year time horizon.
When it comes to income, Wilkinson says investors will derive most of their income from growth assets, particularly in a time of low interest rates. He adds that while investors can tilt their portfolio to listed products that promise higher levels of income, that this can produce portfolios with overweight sector exposure, and lead to underperformance. For example, being overweight to financial services. Wilkinson advises investors to think about the total return of a product, including the capital gain and income, and then draw down when they need to.
Step 2: Populate the buckets
Now it's time to start populating the buckets with listed products.
Growth allocation – international equities
Wilkinson says investors should invest in international equities for three primary reasons:
- Currency as a cushion
- Sector diversification
- Country diversification
When it comes to currency, Wilkinson says international equities act as a "cushion" because the Australian economy is pro-cyclical, meaning when economic times are good, the Australian dollar will rise, but when economic times are bad, the Australian dollar will fall.
"So, when global equities are falling, you're naturally going to get an offsetting hedge there, it's going to cushion that return. It happens on the way up, but also the way down," he says.
The Australian stock market accounts for about 4 per cent of global equities. So, unless you look offshore, that's 96 per cent of markets, sectors and businesses you're not gaining exposure to.
Related article: Investing basics: your guide to diversification
Active international equities
For active listed products – that is a fund where a team of managers make decisions about how to invest the fund's money - Morningstar analysts have two preferred managers with listed products:
- Magellan Global MGE – Silver rated
- Platinum International PIXX – Silver rated
Good but not gold, however. Magellan Global (unlisted version) has a gold rating, while the listed version is Silver. Wilkinson says this is because analysts are yet to see these products trade through sustained periods of volatility and fear the spreads may widen.
"We want to observe what the investor experience is like through volatile times."
However, if you trade well and are a long-term holder, Wilkinson says you've got nothing to worry about.
Source: Morningstar
Passive international equities - developed markets
For passive listed products – or funds that typically track a market index such as the S&P 500 – Wilkinson prefers:
- Vanguard MSCI International VSG – Silver rated
- iShares Core MSCI World All Cap – Silver rated
Without wading too deeply into the active versus passive debate, Wilkinson says following an index is a "perfectly good investment strategy", and in some cases, it's preferred in markets that are very hard to beat. These are markets that are efficient.
"This is the case in US equities, where the vast number of active managers have underperformed the index after fees," he says.
"This is also the case in global equities, where only the top rates active managers are expected to outperform."
"In recent years, the Australian equity market has been hard to beat for active managers – so following an index is a perfectly valid option."
Related article: Investing Basics: A beginner's guide to ETFs
However, Wilkinson says this is less so in emerging markets and small-cap Aussie equities, where analysts think active managers have a better opportunity to outperform the index.
Source: Morningstar
Passive international equities - emerging market equities
Source: Morningstar
International equities - other
Other areas of the global market to consider are infrastructure and global real estate. But Wilkinson warns to be careful of country-specific, sector-specific and commodity bets.
"They're just not overly required, as far as we're concerned," he says.
Source: Morningstar
Growth allocation – Australian equities
Passive Australian equities - large cap
Source: Morningstar
Related article: These ASX200 ETFs are good but not gold, says Morningstar
Australian equities, other
Wilkinson notes that these products should be considered as "supporting players" in a portfolio, not the core.
Source: Morningstar
Defensive allocation – Australian fixed interest
Wilkinson says fixed interest should be a crucial part of all well-balanced portfolio.
"Fixed interest provides protection you need when equity markets get weak and volatile," he says. "Government bonds in particular will rise in value in volatile markets."
Related article: Investing basics: what role do bonds play in a portfolio?
Australia fixed interest - passive
Australian fixed interest - active
Defensive allocation – International fixed interest
International fixed interest - passive
Step 3: Execute the trades
Top tips for putting on a trade:
- Check the market depth and the spread
- Use limit orders wherever possible
- Global products are most prone to wide spreads
- Be most cautious of the mornings and in volatile markets
If Wilkinson could say one thing about good trading practices, it would be to check the market depth and spread before trading. This way investors can ensure they can trade the volume they want and the price they want. The depth is a list of all the buy and sell orders in the market.
"I would love it if all of you could look at market depth before you trade," he says.
"Go onto your trading platform, hit refresh, look at market depth, see what happens, are those inside price changing, spread widening or contracting?
"I bet if you did that at different times of the day, morning versus afternoon, you'll see something different."
The idea, he says, is to not cross the spread when its "really wide" and prices spike.
Investors can check the depth and spread via their brokers.
Wilkinson also advises to avoid trading first 30 minutes or during market volatility. As the ETFs take a while to "wake up".
"Market makers are setting up their procedures, they're sometimes a bit slow, focusing on different products. They can struggle to get net-asset-value (NAV) accurate and in time.
"Products with offshore assets trading can also sometimes take a little while for market makers to work out price and where the NAV should be."
He advises investors to wait about 30 minutes after the opening bell. For similar reasons, he says investors should be on high alert before trading during volatile market conditions altogether, as this is when bid/ask spreads can widen significantly.
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