With over 200 ETFs now listed on the Australian Securities Exchange, selecting just one to invest in might feel like a daunting decision for many.
While most broad-based ETFs provide diversification within an asset class by providing access to a portfolio of shares or bonds, they vary in what asset class exposures they provide. For example, by investing in an Australian shares ETF such as VAS, you are gaining diversification within the broad Australian share market.
So while your Australian ETF gives you a diversified portfolio of Australian shares, it comes with exposure to the market risk of a single asset class. It's therefore important to diversify across asset classes to mitigate those market risks, particularly during periods of heightened market volatility. Being exposed to only Australian equities may mean you have little cushioning within your portfolio in the form of fixed income (bonds) or international assets should local equity markets fall.
One efficient way to gain exposure to a multi-asset portfolio in just one trade is by investing in a diversified ETF. These funds can be particularly efficient if you're in the early stages of constructing a portfolio or, whether it be due to lack of time or resources, prefer not to invest in several individual asset class ETFs to gain a similar multi-asset exposure.
Vanguard's diversified ETFs (and their corresponding managed funds) are carefully constructed by our Investment Strategy Group who review each fund annually to consider new asset classes, currency exposures, home bias, regulatory and tax impacts and investor behaviours.
What is a diversified ETF and what assets are included?
A diversified ETF provides access to a range of asset classes and sectors in just the one fund, and is designed to provide return outcomes over the long-term that correspond with the level of risk assumed. So depending on your investment goals, risk tolerance and time horizon, you can generally select between a conservative, balanced, growth or high growth target asset allocation.
For example, Vanguard's diversified High Growth Index ETF (VDHG) invests 10 per cent of the portfolio in income assets (bonds) and 90 per cent in growth assets (shares), and is suited to those seeking capital growth and those with a higher risk tolerance and longer investment time frame. Zoning in a little more, this means 36 per cent is allocated to Australian shares, 42.5 per cent to international shares (hedged and unhedged), 6.5 per cent to international small companies and 5 per cent to emerging markets. The rest of the fund is allocated to Australian and international fixed interest assets. You can see the target asset allocations for each diversified ETF here.
A key feature of diversified ETFs is that they not only offer access to broad asset classes like equities and fixed income, they also provide exposure to different sub-asset classes (such as domestic and international investment-grade bonds with different maturities) and therefore provides investors with another layer of diversification.
Of course, you could attempt to create a similar portfolio using a variety of ETFs to achieve similar results but the expense ratios and brokerage fees paid across multiple ETFs will add up and subtract from your investment returns.
How can I use Diversified ETFs in my portfolio?
Diversified ETFs can be used as either the core of a combined solution with other investments, or simply as a whole solution.
Depending on your investment plan and the level of control you desire over your portfolio, you can let diversified ETFs form the core of your portfolio (say, 40 to 50 per cent) and then supplement with investments in sectors you are particularly interested in or even with actively managed funds if appropriate.
Whichever strategy you choose, it's important to focus on the core fundamentals of a balanced asset allocation, rather than be distracted by market movements and individual security performances.
What are the advantages of using diversified ETFs?
Aside from instant exposure to multiple asset and sub-asset classes, diversified ETFs are particularly cost effective compared with the fees involved in buying multiple ETFs or individual investments.
They also remove a few common behavioural risks that some investors may face. For example, some may find it challenging to stick to their investment plan when markets get rocky and are consequently tempted to alter their asset allocation. Diversified ETFs can keep investors from switching in and out of the fund's specific assets, thus allowing them to maintain a consistent risk profile no matter how the market moves.
Another example is that many investors have a home country bias where they prefer to invest in local over international assets. Diversified ETFs usually offer access to international assets within the portfolio removing some of the prohibitive factors (such as costs, time and effort) associated with investing in overseas investments.
Diversified ETFs are an accessible and transparent option for many investors and can form a valuable part of any portfolio. To learn more about diversified investments, see here.