Back in February, writing about the newly launched Vanguard’s asset allocation ETFs, I asked why it had taken so long for someone to create an ETF version of the traditional balanced index mutual fund. Now, just 10 months later, Canadian investors who want to build an ETF portfolio with a single trade can choose between two excellent options.
This month, BlackRock Canada launched two one-fund solutions of their own: the iShares Core Balanced ETF Portfolio (XBAL) and the iShares Core Growth ETF Portfolio (XGRO). Like the Vanguard products, these new funds hold several underlying stock and bond ETFs to create a fully diversified portfolio.
Unlike their Vanguard counterparts, however, the new iShares funds are not brand new products. Rather, they’re a reboot of two older funds: the iShares Balanced Income CorePortfolio Index ETF (CBD) and iShares Balanced Growth CorePortfolio Index ETF (CBN). These ETFs had been around since 2007, but they never gained meaningful assets, probably due to their relatively high fees (about 0.75%) and confused strategy (non-traditional indexes, sector funds).
The revamped versions are far more appropriate for Couch Potato investors, as they include only cap-weighted index funds covering the major asset classes. XBAL has a long-term target of 40% bonds and 60% stocks, while XGRO is more aggressive with 20% bonds and 80% stocks. The overall asset mix is broken down as follows:
| Asset class | XBAL | XGRO |
|---|---|---|
| Canadian bonds | 32% | 16% |
| US bonds | 8% | 4% |
| Canadian stocks | 15% | 20% |
| US stocks | 27% | 36% |
| International stocks (developed) | 15% | 20% |
| Emerging markets stocks | 3% | 4% |
| 100% | 100% |
Source: BlackRock Canada
According to the funds’ literature, “it is not expected that frequent changes would be made to [the ETFs’] long-term strategic asset allocation and/or asset class target weights,” which suggests there will be no tactical shifts based on market conditions. That’s good news, since these shifts usually add no value.
Popping the hood
Let’s take a look at how these two ETFs are built, including their individual components and the strategy used to combine them into a diversified portfolio.
The underlying ETFs used to get this exposure includes a combination of Canadian and US-listed funds:
| Canadian bonds | iShares Core Canadian Universe Bond Index ETF (XBB) |
|---|---|
| iShares Cdn Short-Term Corporate + Maple Bond Index ETF (XSH) | |
| US bonds | iShares U.S. Treasury Bond ETF (GOVT) * |
| iShares Broad USD Investment Grade Corporate Bond ETF (USIG) * | |
| Canadian stocks | iShares S&P/TSX Capped Composite (XIC) |
| US stocks | iShares Core S&P Total U.S. Stock Market ETF (ITOT) * |
| International stocks (developed) | iShares MSCI EAFE IMI Index ETF (XEF) |
| Emerging markets stocks | iShares Core MSCI Emerging Markets Index ETF (IEMG) * |
* = US-listed ETF
None of the foreign currency exposure is hedged on the equity side, so any appreciation in the Canadian dollar will negatively affect the ETFs’ returns, while a falling loonie will give them a boost. This is a good long-term strategy: the research is clear that in Canada equity portfolios with exposure to foreign currencies actually have lower volatility than those that try to hedge this risk.
On the bond side, however, all of the US-dollar exposure is hedged. This, too, is the right strategy to use with fixed income. (For more on why it’s important to hedge currency exposure in fixed income, listen to my recent podcast interview with Todd Schlanger, one of the architects behind Vanguard’s asset allocation ETFs.)
As for rebalancing, this will likely be done regularly using new cash flows, which are likely to be significant as the revamped ETFs attract new investors. If that’s not enough, BlackRock says the ETFs “would not be expected to deviate from the asset class target weights by more than one-tenth of the target weight for a given asset class.” In other words, if the target for Canadian bonds is 32%, the fund would be rebalanced if that asset class was over- or underweight by 3.2 percentage points.
iShares vs. Vanguard: How do they differ?
If you’re already familiar with Vanguard’s asset allocation ETFs, you’ve noticed that these new iShares offerings are quite similar to the Vanguard Balanced ETF Portfolio (VBAL) and the Vanguard Growth ETF Portfolio (VGRO), right down to the names and ticker symbols. But the iShares ETFs have a few differences in strategy:
No international bonds. The fixed income allocation of the iShares ETFs is made up of 80% Canadian and 20% US bonds, with no allocation to international bonds. The Vanguard asset allocation ETFs, by contrast, include a blend of Canadian, US and global fixed income.
More corporate bonds. The Vanguard ETFs use only broad-market bond funds, which include mostly government bonds and a smaller amount of corporates. The new iShares funds tilt more toward corporate bonds by adding XSH as about 20% of the Canadian fixed income allocation, and by splitting the US component equally between Treasury bonds and corporates. This makes the iShares funds slightly more risky than their Vanguard counterparts, though all of the bonds are investment grade (no high-yield bonds).
A different mix of Canadian, US, and international equities. XBAL and XGRO allocate a greater share to US stocks (45% of the overall equity allocation) compared with their Vanguard counterparts (40%). The share allotted to Canadian stocks is correspondingly lower at 25% of the overall equity target, compared with 30% in the Vanguard funds.
In both the iShares and Vanguard products, overseas stocks make up about 30% of the equity allocation, but emerging markets make up a smaller proportion in XBAL and XGRO compared with VBAL and VGRO.
Here is the approximate breakdown in each fund:
| Equity asset class | XBAL | VBAL | XGRO | VGRO | ||
|---|---|---|---|---|---|---|
| Canada | 15% | 18% | 20% | 24% | ||
| US | 27% | 24% | 36% | 32% | ||
| International (developed) | 15% | 14% | 20% | 19% | ||
| Emerging markets | 3% | 4% | 4% | 5% |
Lower fee. iShares has always been very competitive on fees, and with these new ETFs they have undercut Vanguard by four basis points: the new funds both have a management fee of 0.18%, compared with 0.22% for VBAL and VGRO. (This includes the fees on the underlying ETFs: there is never any double-dipping on fees in “funds of funds.”) Once taxes are added to that management fee, expect the MER of the iShares funds to be about 0.20% or 0.21%.
Before you buy
I’ve done my best to help investors compare the strategies of the iShares and Vanguard all-in-one ETFs, which leads to the obvious question: which one is a better choice?
Based on what we know about their strategies and costs, I have no strong preference for one over the other. They are all excellent products, and they’re likely to perform very similarly over time, with any variance being the result of randomness and not any structural feature.
If you’re doing more comparison shopping, here’s an important thing to be aware of: because XBAL and XGRO are new mandates for ETFs with a relatively long history (their predecessors were launched 11 years ago), their past performance history is entirely meaningless. As of November 30, 2018, for example, XBAL’s webpage reports an annualized return of 7.41% over the last 10 years. But this performance was what the old CBD racked up with a completely different strategy, so it has zero relevance going forward.
If you’re interested in seeing how the XBAL and XGRO strategies would have performed in the past (using index data minus the ETFs’ current fee), my colleague Justin Bender has backtested both the iShares and Vanguard asset allocation ETFs and published the results on his Model ETF Portfolios page.
Justin’s backtest suggests you can spare yourself any hand-wringing over the iShares vs. Vanguard decision. Over the 20-year period ending November 30, the performance of the comparable ETFs was within a couple of basis points in both returns and volatility.
Avoid a New Year’s surprise
Just one more caveat: if you’re attracted to XGRO and you’re planning to invest in a taxable account, do not buy this ETF until January 2019. That’s because the new mandate of the fund resulted in significant capital gains being realized as the old holdings were sold and replaced. When ETFs and mutual funds realize gains, they pass these along to unitholders at the end of the year. That means if you buy these ETFs in late December, you’ll pay taxes on the capital gains realized before you owned the units—it’s like being handed the bill for dinner at a restaurant even though you showed up after dessert.
iShares has estimated that the capital gains distribution for XGRO will be a whopping 6.84% of its net asset value. If that number is accurate, a $10,000 purchase (about 500 shares) could result in a capital gain distribution of $684, half of which would be taxable at your marginal rate. You can avoid this tax trap by waiting until the new year to purchase the ETF. (iShares does not expect there to be a similar capital gain distribution for XBAL.)
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