Vanguard’s view on portfolio construction and ETF model · Building a diversified equity...
Transcript of Vanguard’s view on portfolio construction and ETF model · Building a diversified equity...
Vanguard’s view on portfolio
construction and ETF model
portfolios
2
Guarded, but not bearish outlook
34%
62%
40%
63%
58%
Economic
outlook
• Low growth,
not stagnation
• 3 structural
forces:
Demographics
Globalisation
Technology
• Uneven but
resilient
• Policy
uncertainty
• Decent
growth, but
dented by
political
uncertainty
• Brexit likely to
be costly for
UK
• Hard landing
unlikely
• Policymakers
in “fighting
retreat”
• Structural
headwinds
• QQE with
yield curve
control
Source: Vanguard.
3
-5%
0%
5%
10%
15%
20%
25%
Global Equity(Unhedged)
Global Bonds(Hedged, USD)
Inflation 20%/80% 60%/40% 80%/20%
Historical Average: 1958-2016
Historical Average: 2000-2016
Return expectations need to be realistic
Projected ten-year nominal return outlook
Source: Vanguard Capital Markets Model (see disclaimer).
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What does Vanguard believe? Focus on elements within your control
Source: Vanguard.
Vanguard’s principles for investing success
Cost
Minimise cost.
Balance
Develop a suitable
asset allocation
using broadly
diversified funds.
Goals
Create clear,
appropriate
investment goals.
Discipline
Maintain
perspective
and long-term
discipline.
Vanguard’s principles for investment success
5
The strategic asset allocation drives the experience
86%
14%
Asset allocation
Security selection and markettiming
Source: Vanguard based on Hong Kong balanced funds, as at February 2014.
Investment return variability is largely determined by the mixture of assets in a portfolio
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Source: Barclays Live, FactSet, and Morningstar as at 31 December 2016. Notes: Benchmarks: Global Bonds: Bloomberg Barclays Global Aggregate Index Hedged to HKD. US Equity: FTSE US.
Japan Equity: FTSE Japan. Europe Equity: FTSE World Europe. Hong Kong Equity: FTSE Hong Kong. World Equity: FTSE MPF All-World.
The next “winning” asset class is impossible to predict
Rank 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
1Japan
Equities
HK
Equities
HK
Equities
Global
Bonds
HK
Equities
HK
Equities
Global
Bonds
HK
Equities
US
Equities
US
Equities
Japan
Equities
US
Equities
2HK
Equities
Europe
Equities
Europe
Equities
Japan
Equities
Europe
Equities
Japan
Equities
US
Equities
Europe
Equities
Japan
Equities
Global
Bonds
Global
Bonds
MPF All
World
Equities
3
MPF All
World
Equities
MPF All
World
Equities
MPF All
World
Equities
US
Equities
MPF All
World
Equities
US
Equities
MPF All
World
Equities
MPF All
World
Equities
Europe
Equities
MPF All
World
Equities
US
Equities
HK
Equities
4Europe
Equities
US
Equities
US
Equities
MPF All
World
Equities
US
Equities
MPF All
World
Equities
Europe
Equities
US
Equities
MPF All
World
Equities
HK
Equities
MPF All
World
Equities
Global
Bonds
5US
Equities
Japan
Equities
Global
Bonds
Europe
Equities
Japan
Equities
Europe
Equities
Japan
Equities
Japan
Equities
HK
Equities
Japan
Equities
Europe
Equities
Japan
Equities
6Global
Bonds
Global
Bonds
Japan
Equities
HK
Equities
Global
Bonds
Global
Bonds
HK
Equities
Global
Bonds
Global
Bonds
Europe
Equities
HK
Equities
Europe
Equities
7
Diversification leads to lower risk across cycles
-10%
-8%
-6%
-4%
-2%
0%
2%
Sources: Vanguard, using data from FactSet, Barclays Live and Bloomberg. Notes: US equities represented by Dow Jones U.S. Total Stock Market Index through April 2005, MSCI US Broad Market Index through June 2013 and CRSP US Total Market Index thereafter; emerging markets equities by MSCI Emerging Markets Index; REITs by FTSE NAREIT Equity REIT Index; dividend stocks by Dow Jones U.S. Select Dividend Index; commodities by S&P GSCI Commodity Index; high-yield bonds by Bloomberg Barclays U.S. Corporate High Yield Bond Index; emerging markets bonds by Bloomberg Barclays EM USD Aggregate Index; investment-grade corporate bonds by Bloomberg Barclays U.S. Corporate Index; US Treasury bonds by Bloomberg Barclays U.S. Treasury Bond Index; hedge funds by HFRI fund-weighted total return Index; and non-US bonds by Bloomberg Barclays Global Aggregate ex-USD Bond Index. The Dow Jones U.S. Select Dividend Index starts in January 1992; Bloomberg Barclays EM USD Aggregate Index starts in January 1993; hedge fund data start in 1994 and Bloomberg Barclays Global Aggregate ex USD Bond Index starts in January 1990. All data provided through 31 December 2016.
Median return of various asset classes during the worst decile of monthly equity returns, 1988–2016
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Diversification
Understanding today, investing for tomorrow
Relative to history, we can expect…
• Low growth
• Low rates
Managing this world requires disciplined investing…
ETF
s
Indexing Low costs
ETFs
Source: Vanguard.
• Low inflation
• Low(er) returns
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Active management has been challenging
Percentage of active funds outperforming the average return of low-cost ETFs over
the five years ending 31 December 2016
Source: Vanguard, using data from Morningstar through 31 December 2016.
36% 36%
49%
16%
44% 43%
0%
20%
40%
60%
80%
100%
Asia ex Japanequity
Japanese equity Emerging marketequity
US equity Global equity Global fixedincome
Perc
enta
ge o
utp
erf
orm
ing
Based on survivors and dead funds
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In a low-return environment, costs matter even more
The long-term impact of investment costs on portfolio balances
Note: The portfolio balances shown are hypothetical and do not reflect any particular investment. The final account balances do not reflect any taxes or penalties that might be due upon distribution.
The data assumes a starting balance of $0 with $40K investing annually and a yearly return of 6%, which is reinvested. Source: Vanguard, using data from Morningstar.
25-year-old investor
Saves HKD 40K
per year for their retirement
Fees
Managed fund: 1.27% pa
ETF: 0.42% pa
HK$0
HK$1,000,000
HK$2,000,000
HK$3,000,000
HK$4,000,000
HK$5,000,000
HK$6,000,000
HK$7,000,000
HK$8,000,000
40 yrs old 50 yrs old 60 yrs old 70 yrs old
Managed Fund ETF
+ HKD 67K
+ HKD 259K
+ HKD 729K
+ HKD 1.8M
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Four Vanguard US ETFs provide global coverage
27%
23%23%
28%
Model portfolio: US-domiciled ETFs
Total US Stock:VTI
Total InternationalStock:VXUS
Total US Bond:BND
Total InternationalBond:BNDX
Sources: Vanguard, using data from FactSet. Notes: Corresponding indices used for each ETF are as follows: VTI: Dow Jones US Total Stock Market through 22 April 2005; MSCI US Broad Market
Index through 2 June 2013; and CRSP US Total Market Index thereafter. VXUS: Total International Composite Index through 31 August 2006; MSCI EAFE + Emerging Markets Index through 15
December 2010; MSCI ACWI ex USA IMI Index through 2 June 2013; and FTSE Global All Cap ex US Index thereafter. BND: Bloomberg Barclays U.S. Aggregate Bond Index through 31 December
2009; Bloomberg Barclays U.S. Aggregate Float Adjusted Index thereafter. BNDX: Bloomberg Barclays Global Aggregate ex USD (USD hedged) through January 2003; Bloomberg Barclays Global
Aggregate ex-USD Float Adjusted RIC Capped Index Back Tested (USD hedged) through January 2013; and Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD
hedged) thereafter.
Portfolio characteristics
Asset class 50% equity/50% fixed income
TER 10 bps asset-weighted
Number of global stocks 9,000+
Number of global bonds 20,000+
Index performance
15-year annualised return 6.1%
15-year annualised volatility 7.8%
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Building a diversified portfolio with Vanguard UCITS ETFs
50%
4%
14%
3%
13%
16%
Diversified portfolio: UCITS ETFs
FTSE All-World UCITS:VWRL
EUR Corporate Bond UCITS:VECP
EUR Eurozone GovernmentBond UCITS:VETY
U.K. Gilt UCITS:VGOV
USD Corporate Bond UCITS:VUCP
USD Treasury Bond UCITS:VUTY
Sources: Vanguard, using data from FactSet. Notes: Corresponding indices for each ETF are as follows: VWRL: FTSE All-World. VECP: Bloomberg Barclays Euro Aggregate Credit – Corporate.
VETY: Bloomberg Barclays Euro Aggregate Government – Treasury. VGOV: Bloomberg Barclays Gilts Float Adjusted. VUCP: Bloomberg Barclays Global Aggregate Corporate – USD. VUTY:
Bloomberg Barclays Global Aggregate - US Treasury Float Adjusted.
Portfolio characteristics
Asset class 50% equity/50% fixed income
TER 19 bps asset-weighted
Number of global stocks Nearly 3,000, 88% of total
market-cap
Number of global bonds 1,000+, 55% of total
market-cap
Index performance
15-year annualised return 6.7%
15-year annualised volatility 9.5%
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Building a diversified equity portfolio with Vanguard Hong Kong ETFs
57%
10%
23%
9%
Equity portfolio: Hong Kong-domiciled ETFs
S&P 500:3140
FTSE Asia exJapan Index:2805
FTSE DevelopedEurope Index:3101
FTSE Japan IndexETF:3126
Sources: Vanguard, using data from FactSet.Notes: Corresponding indices for each ETF are as follows: 3140: S&P 500. 2805: FTSE All-World Asia Pacific ex Japan Australia New Zealand. 3101:
FTSE All-World Developed Europe. 3126: FTSE Japan.
Portfolio characteristics
Asset class 100% equity
TER 18 bps asset-weighted
Number of global stocks 2,000+, 78% of total market-cap
Index performance
15-year annualised return 6.4%
15-year annualised volatility 15.4%
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A caution… product proliferation does not mean diversification
Liquidity
Large-cap
Mid-cap
Small-cap
Growth
Value
FTSE 100
Momentum
Russell
1000
Russell
2000 Fundamental
indicesEnhanced
indices
FTSE
RAFI
Developed
1000
Smart Beta
Alternative-
weighted indices
β/α
Minimum
volatility
index
Factors
Source: Vanguard.
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Higher expected return comes with higher risk
Long-term risk-adjusted returns, more similar than different
Notes: Dotted line indicates trend of risk and return for selected US benchmarks. Benchmarks are as follows: US 30-day T-bill represented by IA SBBI US 30 Day T-Bill TR Index; US intermediate-
term government bond represented by IA SBBI US IT Govt TR Index; US long-term corporate bond represented by IA SBBI US LT Corp TR Index; “Large-growth” represented by Fama-French Large
Growth TR Index; ”Large-value” represented by Fama-French Large Value TR Index; “Small-growth” represented by Fama-French Small Growth TR Index; “Small-value” represented by Fama-French
Small Value TR Index. Index names as reported by Morningstar; all are total-return indices. Source: Illustration by The Vanguard Group, Inc., using data from Vanguard and Morningstar, Inc.
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LiquidityStructure
Selecting which ETFs to use
• Global manager
• Support and resources
• Service model
• Physically backed
• Leveraged and inversed
• Synthetics
• ETF liquidity
• Benchmark liquidity
• Liquidity providers
Source: Vanguard.
Provider
2 31
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Fund vs. ETF: The holding period matters
Source: Vanguard.
Expense ratio
Mutual fund
> ETF
Mutual fund
< ETF
Mutual fund
> ETF
Scenario 1:
ETF costs less
Scenario 2:
Breakeven-period
analysis required
(shorter favors ETF)
Mutual fund
< ETF
Scenario 4:
Breakeven-period
analysis required (shorter
favors mutual fund)
Scenario 3:
Mutual fund costs lessTra
nsaction c
osts
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Notes: This illustration does not represent the returns of any particular investment. Assuming a portfolio of 50% global stocks and 50% global bonds. All returns are in nominal US dollars. For
benchmark data, see “Best Practices for Portfolio Rebalancing,” November 2015 by Ziberling, et al. There were no new contributions or withdrawals. Dividend payments were reinvested in equities;
interest payments were reinvested in bonds. There were no taxes. All statistics were annualised. Source: Vanguard calculations, using data from FactSet.
Rebalancing is critical to maintaining the portfolio
The most important aspect of rebalancing is to have a rule
Monitoring frequency Monthly Quarterly Annually
Threshold 0% 1% 5% 10% 1% 5% 10% 1% 5% 10% NA
Average equity
allocation 50.1% 50.1% 51.2% 52.2% 50.2% 50.9% 51.0% 50.6% 51.2% 52.4% 80.6%
Costs of rebalancing
Annual turnover 2.6% 2.3% 1.6% 1.3% 2.1% 1.5% 1.2% 1.7% 1.6% 1.5% 0.0%
Number of
rebalancing events1,068 423 64 24 227 50 22 79 36 19 0
Absolute framework
Average annualised
return 8.0% 8.0% 8.1% 8.3% 8.2% 8.3% 8.3% 8.1% 8.2% 8.3% 8.9%
Annualised volatility 10.1% 10.1% 10.1% 10.2% 10.1% 10.2% 10.1% 9.9% 9.8% 10.0% 13.2%
Never
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Focus on the
controllable.
Think globally.Asset allocation
drives returns.
ETFs are a great way to meet client needs
Source: Vanguard.
2 31
2020
Appendix
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Rolling 3-year correlation betweenUCITS 50/50 index and global benchmark
98.0%
98.5%
99.0%
99.5%
100.0%
2004 2007 2010 2013 2016
Correlation across
the whole period
Sources: Vanguard, using data from FactSet. Notes: Corresponding indices for each ETF in the UCITS portfolio are as follows: VWRL: FTSE All-World. VECP: Bloomberg Barclays Euro Aggregate
Credit – Corporate. VETY: Bloomberg Barclays Euro Aggregate Government – Treasury. VGOV: Bloomberg Barclays Gilts Float Adjusted. VUCP: Bloomberg Barclays Global Aggregate Corporate –
USD. VUTY: Bloomberg Barclays Global Aggregate - US Treasury Float Adjusted. The 50/50 benchmark used for comparison assumes an equal split between equity, as represented by MSCI AC
World Investable Market Index through September 2003; and FTSE Global All Cap Index thereafter, and bonds, as represented by Bloomberg Barclays Global Aggregate Index.
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Rolling 3-year correlation between Hong Kong index portfolio and equity benchmark
99.0%
99.5%
100.0%
2004 2007 2010 2013 2016
Correlation across
the whole period
Sources: Vanguard, using data from FactSet.Notes: Corresponding indices for each ETF in the HK equity portfolio are as follows: 3140: S&P 500. 2805: FTSE All-World Asia Pacific ex Japan Australia
New Zealand. 3101: FTSE All-World Developed Europe. 3126: FTSE Japan. The equity benchmark used for comparison is represented by MSCI AC World Investable Market Index through September
2003; and FTSE Global All Cap Index thereafter.
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Fund flows often follow performance
Net cash flow into equity funds vs. relative global equity/bond market performance
Source: Vanguard, using data from the Hong Kong Investment Association and Datastream through 31 January 2017.
-60%
-40%
-20%
0%
20%
40%
60%
-12,000
-8,000
-4,000
0
4,000
8,000
12,000
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Rolli
ng a
nnual re
lative g
lobal equity
vs.
glo
bal bond r
etu
rn (
%)
Rolli
ng a
nnual net
equity
flow
(U
SD
m
illio
n)
Net equity flow (USD million, LHS) Relative equity / bond market return (%, RHS)
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Building a diversified portfolio with Vanguard UCITS ETFs
Asset allocation by product
Ticker
Expense
ratio 0/100 10/90 20/80 30/70 40/60 50/50 60/40 70/30 80/20 90/10 100/0
Equity
FTSE All-World UCITS VWRL 0.25% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% 100.0%
Fixed income
USD Treasury Bond UCITS VUTY 0.12% 31.7% 28.5% 25.4% 22.2% 19.0% 15.9% 12.7% 9.5% 6.3% 3.2% 0.0%
EUR Eurozone Government Bond UCITS VETY 0.12% 28.9% 26.0% 23.1% 20.2% 17.3% 14.4% 11.6% 8.7% 5.8% 2.9% 0.0%
USD Corporate Bond UCITS VUCP 0.12% 26.1% 23.5% 20.9% 18.3% 15.6% 13.0% 10.4% 7.8% 5.2% 2.6% 0.0%
EUR Corporate Bond UCITS VECP 0.12% 8.2% 7.3% 6.5% 5.7% 4.9% 4.1% 3.3% 2.4% 1.6% 0.8% 0.0%
U.K. Gilt UCITS VGOV 0.12% 5.1% 4.6% 4.1% 3.6% 3.1% 2.6% 2.1% 1.5% 1.0% 0.5% 0.0%
Asset-weighted expense ratio 0.12% 0.13% 0.15% 0.16% 0.17% 0.19% 0.20% 0.21% 0.22% 0.24% 0.25%
Index performance
15-year annualised return 5.7% 5.9% 6.2% 6.4% 6.6% 6.7% 6.8% 6.8% 6.8% 6.8% 6.6%
15-year annualised volatility 6.9% 6.9% 7.2% 7.8% 8.6% 9.5% 10.6% 11.7% 13.0% 14.3% 15.7%
Asset allocation (%)Equity / Fixed income
Sources: Vanguard, using data from FactSet, as at 31 December 2016. Notes: Corresponding indices for each ETF are as follows: VWRL: FTSE All-World. VECP: Bloomberg Barclays Euro Aggregate
Credit – Corporate. VETY: Bloomberg Barclays Euro Aggregate Government – Treasury. VGOV: Bloomberg Barclays Gilts Float Adjusted. VUCP: Bloomberg Barclays Global Aggregate Corporate –
USD. VUTY: Bloomberg Barclays Global Aggregate - US Treasury Float Adjusted.
25
Index performance of a Vanguard UCITS ETF portfolio
Returns and volatility of underlying indices
0/100 10/90 20/80 30/70 40/60 50/50 60/40 70/30 80/20 90/10 100/0
15-year annualised return 5.7% 5.9% 6.2% 6.4% 6.6% 6.7% 6.8% 6.8% 6.8% 6.8% 6.6%
15-year annualised volatility 6.9% 6.9% 7.2% 7.8% 8.6% 9.5% 10.6% 11.7% 13.0% 14.3% 15.7%
10-year annualised return 3.6% 3.8% 4.1% 4.2% 4.4% 4.5% 4.5% 4.6% 4.5% 4.4% 4.3%
10-year annualised volatility 6.9% 7.2% 7.8% 8.6% 9.5% 10.6% 11.8% 13.0% 14.3% 15.7% 17.1%
5-year annualised return 2.1% 2.9% 3.7% 4.5% 5.3% 6.1% 6.9% 7.7% 8.5% 9.3% 10.1%
5-year annualised volatility 4.5% 4.7% 5.2% 5.7% 6.4% 7.1% 7.9% 8.7% 9.6% 10.5% 11.4%
3-year annualised return 0.2% 0.5% 0.9% 1.3% 1.6% 2.0% 2.4% 2.7% 3.1% 3.5% 3.8%
3-year annualised volatility 4.5% 4.5% 4.8% 5.2% 5.9% 6.6% 7.4% 8.3% 9.3% 10.2% 11.2%
Sources: Vanguard, using data from FactSet, as at 31 December 2016. Notes: Corresponding indices for each ETF are as follows: VWRL: FTSE All-World. VECP: Bloomberg Barclays Euro Aggregate
Credit – Corporate. VETY: Bloomberg Barclays Euro Aggregate Government – Treasury. VGOV: Bloomberg Barclays Gilts Float Adjusted. VUCP: Bloomberg Barclays Global Aggregate Corporate –
USD. VUTY: Bloomberg Barclays Global Aggregate - US Treasury Float Adjusted.
Asset allocation (%)Equity / Fixed income
26
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About Vanguard Capital Markets Model (VCMM): The Vanguard Capital Markets Model is a proprietary financial simulation tool developed and maintained by Vanguard's primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include Australian and international equity markets, several maturities of the Australian Treasury and corporate fixed income markets, international fixed income markets, money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the VCMM is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.
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Reference no.: VIHK-2017-04-20-1980