Advisers should treat exotic ETFs with caution
A low-cost, diversified core portfolio with only a few exciting satellite exchange traded funds (ETFs) may be the best way for financial advisers to help their clients build wealth without taking on too much risk.
The full Australian ETF menu is truly world class— access to entire markets and diversified portfolios, both global and local, are available with just one click.
Innovation in the Australian ETF space is also booming, with ETF providers capitalising on investors’ interest by launching new products in specific industry sectors, themes and more exotic areas of the market. For example, Australian investors even have access to cryptocurrency ETFs.
But while this product proliferation is exciting, advisers should consider the risks of shiny new thematic ETFs before recommending them. Many within this new wave of more exotic ETFs are highly concentrated or highly volatile.
A core-satellite approach can keep your client’s portfolio interesting without risking everything
One alternative to going all in with thematic or exotic ETFs is the core-satellite approach, where the majority of the portfolio is allocated to broad-based, diversified ETFs and a small portion of the portfolio is set aside to actively trade these more concentrated ETFs.
The benefits of diversification are well established. Diversifying within and across asset classes helps investors manage risk by spreading it across many different assets.
If the idea of a generally "boring" portfolio chafes, consider the well-researched theory that almost 90% of a portfolio's long-term returns are determined by asset allocation, with security selection and market timing playing only minor roles in comparison. 1
The ETF has come a long way since it was launched in Australia in 1993. Investors now hold more than $128 billion in over 250 different Australian-listed ETFs.
Pleasingly, growth and competition in ETFs is driving costs and management expense ratios down. Recent Vanguard analysis conservatively estimates that indexing and ETFs have delivered investors over $4 billion in cost savings in Australian equities alone.
Boring is best when it comes to building long-term wealth
The success of ETFs can in part be attributed to another important financial innovation from the 20th century—the index fund. Index ETFs give advisers access to powerful portfolio construction tools, allowing them to create highly diversified solutions matched to their client’s risk profile.
Whether in Australia or overseas, the lion's share of ETF assets are managed through an index approach and benchmarked to broad market, well-diversified indexes.
The plethora of options includes vanilla equity and fixed income index ETFs as well as actively managed equity and fixed income ETFs, diversified environmental, social and governance (ethically conscious) ETFs, and even multi-asset ETFs.
Being boring works when it comes to building your clients’ long-term wealth. Just like how regularly eating a healthy diet with an occasional treat helps to keep your body in shape, a low-cost, diversified core portfolio with only a few exciting satellite ETFs could do the same for your clients’ investments.
Discover Vanguard’s range of core ETF solutions.
Disclaimer:
Vanguard Investments Australia Ltd (ABN 72 072 881 086 / AFS Licence 227263) is the product issuer and the Operator of Vanguard Personal Investor. We have not taken yours or your clients’ circumstances into account when preparing this content so it may not be applicable to the particular situation you are considering. You should consider yours and your clients’ objectives, financial situation or needs, and the Product Disclosure Statement (“PDS”) and the IDPS Guide ("the Guide"), before making any investment decision or recommendation. A copy of the Target Market Determinations (TMD) for Vanguard's financial products is free of charge and include a description of who the financial product is appropriate for. You can access our disclosure documents at
vanguard.com.au or by calling 1300 655 205. Past performance information is not an indication of future performance. © 2022 Vanguard Investments Australia. All rights reserved.
1Source: Brinson, Hood and Beebower, 1991.
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