Mastering asset allocation with ETFs

The aim of many investors is to develop a resilient investment portfolio that stands the test of time. While unlisted managed funds used to be the vehicle of choice for investors looking to allocate to different asset classes, Australian investors have increasingly been opting for exchange-traded funds (ETFs). The ETF industry reached a record $150 billion in funds under management as at 30 June 2023, earlier than forecast, and for good reason. Using ETFs to create resilient portfolios at a lower cost than active managers.

The ASX says “The continued popularity of ETFs is no surprise, given their ability to provide investors with exposure to a wide range of companies, regions, asset classes and strategies, making it easier to diversify.” Furthermore, investors who hold ETFs were most likely “to be seeking diversification opportunities, looking for a balance between risk and return, aiming to maximise their capital growth or secure a sustainable income stream. They appeal to both high-value investors and SMSF owners.”

In other words, ASX ETF investors are creating their own diversified portfolios. This asset allocation decision is, perhaps the most important they will make.

In the 1986 article “Determinants of Portfolio Performance”, Brinson et al, demonstrated that the asset allocation decision was responsible for 93.6% of a diversified portfolio's return pattern over time. Subsequent studies have confirmed this (Donaldson et al, 2013). The asset allocation decision is responsible for around 90% of portfolio movements, while the remaining 10% comes from security selection and market timing.

Asset allocation is a critical element of any investment strategy. It forms the basis of a prudent investment policy and drives the bulk of an investor’s risk and return outcome.

We believe a diversified approach to portfolio construction is critical to achieving investment objectives. VanEck’s model portfolios are split between growth and defensive assets across a range of ETFs that aim to give investors suitable exposure to the relevant asset class.

An informed understanding of risk and return of the various asset classes is important to the portfolio construction process. The Australian Government (moneysmart.gov.au) has provided investors with a practical guide to investing called “Investing between the flags” which highlights typical investment portfolios including ‘balanced’ and ‘growth’ mixes based on desired return outcomes, having regard to investors’ different timeframes and levels of risk. Portfolios targeting high growth have 100% allocated to growth assets.  ASIC defines defensive assets as cash or government bonds, so for the purposes of the below defensive assets are Australian bonds, international bonds and cash. This means the growth assets below are: Australian equities, international equities, Australian property, international property and global infrastructure.

Growth assets are considered riskier than defensive assets, so a high-growth portfolio is riskier than a balanced portfolio.

Below is an example of typical asset allocation in balanced, growth and high-growth portfolios.

Each model portfolio provides broad market exposure across asset classes including Australian equities, global equities, property, infrastructure, Australian fixed income and international fixed income. You will note it includes VanEck’s ETFs, as well as funds from our ETF peers, where we do not have an equivalent capability. The portfolios include a mix of ‘beta’ and ‘smart beta’ strategies, utilising simple low-cost ETF strategies to deliver diversified exposure for considerably less cost than the average cost of Australian managed funds.

Warning: This is general advice only about financial products and not personal financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Before making any asset allocation or investment decision, you should seek personal financial advice from a licensed financial adviser to determine your risk profile and financial products that are appropriate for your personal circumstances.

The table below show the returns of hypothetical portfolios based on the asset allocations outlined above.

Period returns for periods endings 30 June 2023 

Source: Lonsec. Past performance is not a reliable indicator of future performance. The Model Portfolios are notional portfolios. Model Portfolio performance is calculated after management fees and before taxes. 

As you can see from the above table a hypothetical one-year investment in our model high growth portfolio for the period ending 30 June 2023 would have returned a whopping 18.45%. It’s important to remember that high-growth technology companies have soared this year riding a wave of enthusiasm for the emerging field of generative AI. It’s been a welcome recovery from a lacklustre 2022 performance where tech fell heavily and was a casualty of rising inflation and interest rates on a global scale as the cost of money became more expensive. Notwithstanding last year's poor performance, a hypothetical investment in our high-growth model portfolio over 5 years to 30 June 2023 would still have netted a return of over 10%.

The hypothetical returns are demonstrative of the benefits diversification can have for investors as a long-term portfolio strategy and how investors are using ETFs to achieve their investing goals.

An investment in any fund involves risk. As always, we would recommend you speak to a financial adviser or broker to determine which investment portfolio is right for you.