The World of ETFs

đź“Š Investing
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Hi, Everyone; I wanted to create this new thread as a central point for having conversations about all ETF-related topics.

I will kick this off by proposing a portfolio that could be used to build a pension pot or for any long-term investment goal.

With this portfolio, I am looking to achieve long-term capital growth with balanced risk through diversification across U.S. large-cap, international (Ex US), emerging markets, and small-cap equities. I have also added a U.S. Treasury bonds for stability (a global bond ETF might be another option). The portfolio focuses on geographic and market capitalization diversification, income reinvestment, and low-cost investing, aiming to maximise returns while mitigating volatility.

Moreover, I have used ETFs that can be bought on the LSE.

I also have a couple of options for slightly different weight distribution.

Vanguard S&P 500 UCITS ETF (USD) Accumulating: 35% (or 40%)
Xtrackers MSCI World ex USA UCITS ETF 1C: 25% (or 20%)
Vanguard FTSE Emerging Markets UCITS ETF Acc: 15% (or 10%)
Invesco S&P SmallCap 600 UCITS ETF A: 10% (or 15%)
Vanguard USD Treasury Bond UCITS ETF Accumulating: 15%

Looking forward to reading some thoughts.

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I’m sure this would perform OK but it’s perhaps overcomplicated. You could boil it down to a handful of holdings. I think there’s a lot to be said for a simple Bogleheads-style one-, two- or three-fund portfolio.

But the biggest issue I have with this type of approach is that it almost runs counter to the whole point of passive investing, which is surely to guarantee the same return as the broad market minus a small fee.

By mixing, matching and making all manner of active decisions, overweighting this and underweighting that, you could outperform but you risk underperforming too.

You’re effectively constructing an active fund with various ETFs. It’s just my 2p worth but I prefer the passive portion of my portfolio to be just that.

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Thanks for your feedback @topher , it’s much appreciated.
I am all for simplicity, and I agree with the great majority of your comments. I have a reduced version of that which Inwill post later (i.e., replacing S&P500 and World Ex Us with a World ETF including US).
How would you adjust this?
Cheers!

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Putting more gasoline in the fire. :smiley:

Following your Large Caps approach with US + ex-US + EM, why use only a US Small Caps, why not an ex-US or Europe+UK+Canada+Australia+Japan Small Caps and an EM Small Caps?

Or to avoid US + ex-US or the train of Countries/Regions Small Caps (maybe not all existent), using a Developed Small Caps ETF (e.g. MSCI World Small Caps). Or MSCI ACWI or equivalent index that includes DM + EM Small Caps ETF.

Does the 5 ETFs contributes positively to the portfolio? What are the returns, sharpe and sortino ratios and standard deviations just to be simple in analyzing?

Sometimes more, only complicates, and it marginally provides positive outcomes.

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No worries. I’d suggest a global equity ETF and a global bond one would achieve much of the same and address the quasi-active fund concern.

Whether you go with Ftse all-world, MSCI world or the S&P is down to taste.

If you really want small-caps, some funds such as Vanguard’s global all-cap include them and there are some global small-cap ETFs like WLDS.

You could use a US small-cap ETF as a proxy but I’d rather pay a higher ongoing charge for a Russell 2000 one like R2SC.

It’s much bigger (£2bn vs £60m), more liquid so you’ll probably get a better spread/execution, and denominated in GBP so you won’t incur an FX fee.

In reality, a small additional slice of smallcaps is unlikely to make that much of a difference in the long-term so I wouldn’t bother.

I think it pays to keep passive investing as simple as possible.

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Hi, just to be clear, I’m not teasing you @topher. :wink:

I just took your sentence as a starter to address questions to @RealValueInvesting.

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Thanks both @topher and @RLX for sharing your thoughts. I wanted to pick up on a comment from @RLX about the Sharpe ratio, and how I tend to do it, which is slightly different.
So, I will try to explain my point using some examples I found online and I will use cars as I am a bit of a petrolhead :wink:.

Imagine we are comparing two rally cars. One of the drivers is fast but inconsistent, sprinting and slowing down unpredictably. The other driver is steadier, maintaining a consistent pace. If we were to look at their overall times, we might miss that one driver had a choppy drive while the other was more reliable.

The Sharpe Ratio is like judging those drivers and their cars purely by their overall speed relative to how erratic they were. It tells us how much return we got for every unit of risk we took on. However, sometimes, that might not be the whole story.

Now, let’s think about how we might prefer to watch a race. We might want to see how these runners would perform if they were running on the same track at the same pace. That is where the Modigliani-Modigliani (M2) measure comes in. It adjusts the race so both runners are running with the same level of risk (or volatility), and then shows us how much better (or worse) one did than the other.

The M2 measure translates everything into the same language and as a result provides an easier comparison. Returns are adjusted for a common risk level, making it super easy to compare our portfolio with a benchmark like the S&P 500 or FTSE 100, because it puts them on a level playing field.

Moreover, what we often want to know (I am speaking for myself at least): “Am I doing better than the market?” The M2 measure tells us this in a straightforward way. By adjusting our portfolio’s risk to match the market’s, it answers: “If my portfolio had the same risk as the market, how much would I have earned?” This is much closer to how I personally think about investment success.

Another interesting point is that the Sharpe Ratio might penalize a portfolio for having more volatility, even if that volatility comes with higher returns that we might be happy with. Conversely, The M2 measure shows how that risk translates into actual, tangible performance against the market, which in my case is what I care about.

I am getting there, I promise…the M2 measure can be seen as a better method because it converts abstract risk-adjusted performance into a simple return percentage, making it easier to see how our portfolio or single ETF stack up against the market. So in essence, the Sharpe Ratio is like judging a pizza by how cheesy it tastes compared to the amount of cheese used, which still gives us a score but perhaps not the whole picture. The M2 measure is like tasting two pizzas made with the same amount of cheese, and it directly shows which one is tastier.

I will provide some figures about one of the ETFs in the portfolio I posted to show what I am talking about.

Does this make sense at all? Please let me know and feel free to chip in. I am genuinely here to help as much as to learn!

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All I have is one ETF FWRG.

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I have a version of the porfolio with iShares MSCI World Small Cap UCITS ETF; however, the TER is 2.5 times bigger than the S&P Small Cap. Moreover, the World ETF’s hystorical performance is lower than the S&P’s ETF. I know historical performance doesn’t guarantee future performance; however, that is the only thing Ive got. That said, the World ETF option is still o the table.

I am trying to achieve a low overall TER. I have benn running simulations on several portfolios using backtesting and the Montecarlo method, and so far, the portfolio above seems to be one of the best performers in terms of returns and volatility.

That said, I will post more portfolios, some of those in line with your comments, so we can all have some fun :wink:

Why this one in particular? I am asking because there are comparable ETFs with a lower TER. Moreover, what is your purpose and time horizon when looking into this product?

This is definitely another option; however, I am thinking again about a higher TER, which for some people might not be enticing. I totally get your point, though.

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The term you should be using is OCF.

All European ETFs quote the OCF, which is similar but different to a TER.

Also FWRG has one if not the cheapest OCF for an ETF tracking the FTSE all world.

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Can you please expand on this? Thanks
Do you mean this: " The only difference being that the TER does not cover any performance fees or one-off charges . For this reason, the OCF gives the most accurate measure of what it actually costs to invest in a fund"

Would be able to show the difference between TER and OCF for that ETF and provide links to the sources?
I am asking because as far as I can see both OCF and TER are equivalent for this ETF.

What I see is that for many ETFs, the TER and OCF are often the same or very close, especially when there are no performance fees or significant other costs.
Please advise if you see anything else.

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You can also take a look at this link just to get some further info about World ETFs.

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You need to look up the ESMA guidelines, this is where asking an AI is not very helpful, as it doesn’t validate sources very well.

An OCF, as quoted for UCITS is put simply the TER plus custody transaction charges. All funds have custody transaction fees, and some markets are more expensive than others, which is why they can appear close, but are in fact different.

Similarly the trading212 definition appears to be wrong:

https://www.trading212.com/learn/investing-101/ter-total-expense-ratio#

Extract:

Unlike the TER, the ongoing charges figure typically does not include transaction costs incurred from buying and selling securities within the fund, except in certain cases where these costs are included in the ongoing charges figure for funds marketed in the European Union under regulations like UCITS (Undertakings for Collective Investment in Transferable Securities).

212 could swap the two in bold and remove the word typically, but I will leave that to someone at 212 to check (@Bogi.H you might want to get someone to check this). I would probably reword the full statement here.

Here is the EU guidelines:

https://www.esma.europa.eu/document/guidelines-methodology-calculation-ongoing-charges-figure-in-key-investor-information

Lots of websites / users still use both names when they are in fact different. Look at a KIIDs document, they should quote Ongoing Charge when UCITS.

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That is exactly what I have done and in this case it is the same as the TER (see link below)
/https://api.fundinfo.com/document/5d1f829230476845d0d5390b44b046c1_294123/KID_GB_en_IE000716YHJ7_YES_2024-02-16.pdf

Am I right, or missing anything?

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Your link refers to the Ongoing Charge Figure of 0.15%, it doesn’t quote the TER.

That said, if you look at the financial statements:

IMG_0017
IMG_00172360Ă—187 69 KB

So only because the manager pays for all operating expenses and only charges a management fee back to the fund, is the reason the TER and OCF happen to be the same.

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That is what I was talking about, and it is the same for many ETFs (you can check).
So, to ensure we are aligned, I agree you should look at the KIIDs documents; however, OCF and TER are often the same for ETFs.

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There are not many managers that pay all the fund fees.

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I kindly invite you to take a deeper dive into it to appreciate that there might be more TFs than you realise where the TER is the same as the OCF.

In the case of the EXUS, their ETR includes all fees (see below)

image

However, I do agree that some differ. For example, see the figures below related to VUAG
image

That said, I would like to pull this conversation back to the primary purpose of analysing potential long-term growth portfolios.

Have you got any suggestions?

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I agree that a three-fund portfolio could work very well. However, there is still some flexibility about how you might want to compose it (e.g., US bond, World bond, European bond, etc.). Moreover, you could decide whether to use a developed World ETF or one that includes EM.

That said, you will end up with a World ETF (including the US) and a bond ETF, which makes it a two-fund portfolio.
On the other hand, you can use a core US such as the S&P500, a World Ex US and Bond.

The only slight issue I have with the three-fund portfolio is that to replicate the three funds (see below), you need more than three ETFs.

  • Vanguard Total Stock Market Index Fund (VTSAX) - U.S. equities, including small, mid and large cap growth and value stocks.
  • Vanguard Total International Stock Index Fund (VTIAX) - Exposure to developed and emerging markets Ex U.S.
  • Vanguard Total Bond Market Fund (VBTLX) - U.s. investment-grade bonds (somebody might want broad exposure)

Why don’t we put together something and post it here? I would do this by using products that are available in the UK, if that’s OK.

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It depends what the thread was intended for “The World of ETFs” is vague and could cover every ETF out there.

The key is not just in operational costs, but tracking error to an index whatever ETF you look at.