The essence of indexing - an investment strategy pioneered by Vanguard founder Jack Bogle and the foundation upon which ETFs were created – is ultimately about providing investors broad market exposure.
By gaining broad exposure to markets, ETF investors do not need to select the winning investment (a difficult feat for even trading professionals), but rather, they can choose to buy the whole market and reduce the risk of relying on the performance of one or a few select securities. This makes them a suitable option for first-time investors who might not have the time or skill to pick and choose investments, but would still like to participate in the market.
Broad-based ETFs, as the name suggests, are ETFs that track the returns of a broad, well-established index that comprises hundreds, sometimes thousands, of securities.
For example, Australia’s most popular broad-based ETF is the Vanguard Australian Shares Index ETF (VAS) which seeks to track the returns of the S&P/ASX300 index. This means when investors invest in VAS, they are effectively investing in the top 300 companies listed on the Australian Securities Exchange, proportionate to their market capitalisation.
There are also many other broad-based ETFs available to Australian investors that cover different asset classes and markets, such as fixed income, property, international markets, emerging markets, ESG and more.
The benefits of broad-based ETFs
Not only do broad-based ETFs offer investors inherent diversification benefits, but they also provide exposure to a group of securities at a cost much lower than if investors were to individually purchase them and pay brokerage on every transaction. Broad-based ETFs also generally have lower transaction and management fees than actively managed funds.
Broad-based ETFs are also transparent – from the product disclosure statement, investors can view what securities the ETF is invested in and any associated costs, and from their brokerage platform, have visibility over their trading price and net asset value.
Suitable for any portfolio
Broad-based ETFs can have a place in almost every portfolio, depending on the investor’s goals, risk tolerance and asset allocation.
For beginner investors, a multi-asset ETF such as the Vanguard Diversified High Growth Index ETF (VDHG) can be a suitable first investment.
VDHG is a diversified broad-based ETF that provides access to multiple asset classes in the one trade (i.e. both shares and bonds), and benefits from Vanguard’s deep investment management expertise. It does this by tracking the returns of various indices in proportion to its strategic allocation. For VDHG, this means investing 90 per cent in growth assets such as Australian and International Shares and 10 per cent in income assets such as Australian and International fixed income.
By investing in VDHG, investors gain another level of diversification through its exposure to more than just one asset class and market. For example, if there’s a downturn in equities, bonds are likely to cushion that fall as they move in opposite directions. Holding both asset classes will lower the portfolio risk.
For investors who wish to construct their own portfolio, broad-based ETFs can be mixed and matched according to the investor’s target asset allocation. Say you have $10,000 to invest and wish to put half in growth assets and the other half in income assets to build a balanced portfolio, you could invest $5,000 in domestic or international equity or property ETFs, and $5,000 in domestic or international fixed interest ETFs.
Alternatively, broad-based ETFs can be used in a core-satellite approach where they form the majority of an investment portfolio and select securities or active investments that seek to outperform the market are used to complement.
The broad and narrow
While all ETFs are designed to track the returns of a particular index, it’s worth noting that not all indexes are equally broad and diversified.
Thematic ETFs, which have seen a surge in popularity lately, differ from broad-based ETFs as they encompass a narrower universe of securities that has been constructed around a particular theme or trend.
For example, ETFs tracking cryptocurrency related companies, social sentiment, and electric vehicles indexes are very specialised, and while they offer access to “hot” sectors and the opportunity to outperform the broader market, they are also constructed around trends that may not stand the test of time. Because of this, thematic ETFs are generally used for short-term trading rather than long-term investing, which subsequently increases investment costs.
Vanguard has long advocated that broad diversification, transparency and long-term investment merit is what makes for a good index, and by extension, a good ETF.
Smart Investing, Vanguard