In the brief time they’ve been around, asset allocation ETFs have transformed the way DIY index investors manage their portfolios. These balanced funds have become the default choice, as it’s harder and harder to justify adding more moving parts and more complexity to a portfolio by using individual ETFs for each asset class.
While other fund providers now offer their own versions, the Vanguard and iShares asset allocation ETFs remain the most popular, and for good reason. I’ve included both in my model portfolios because you can’t go too far wrong with either family. Vanguard and iShares both offer five options, with equity allocations ranging from 20% for conservative investors, all the way up to 100% for the most aggressive. Each fund combines several underlying ETFs, which invest in thousands of individual stocks and bonds, providing Canadian investors with extensive global diversification.
|Asset Mix||Vanguard ETF||iShares ETF|
|20% equities / 80% bonds||VCIP||XINC|
|40% equities / 60% bonds||VCNS||XCNS|
|60% equities / 40% bonds||VBAL||XBAL|
|80% equities / 20% bonds||VGRO||XGRO|
But that’s not to say they’re identical. The Vanguard and iShares families have several differences in composition and strategy. None of these is terribly dramatic, but they’re worth understanding if you’re looking to make an informed choice. In our latest blog-and-video joint venture, Justin Bender and I present a head-to-head comparison of the Vanguard and iShares asset allocation ETFs.
Before we dive into the details, let’s address the most obvious difference: fees. The iShares portfolios are slightly less expensive at about 0.20%, compared with 0.25% for the Vanguard funds. A margin of five basis points would be a good tiebreaker if the funds were exactly the same in all other respects. But as we’ll see, they’re not, so this shouldn’t be your only point of comparison. And let’s say it again: costs are always important, but unless your portfolio is very large, small differences don’t add up to a lot of dollars. On a $100,000 balance, five basis points is less than $1 a week.
We’ll start our comparison by looking at the allocation to Canadian stocks. Our country makes up only about 3% of the global equity market, but Vanguard and iShares both overweight domestic stocks in their asset allocation ETFs. Vanguard assigns 30% of their equity mix to Canadian stocks, and 70% to foreign stocks. iShares goes with 25% Canada and 75% foreign.
Based on recent performance, you may be tempted to favour the iShares ETFs, with their higher allocation to foreign stocks. After all, during the decade ending December 2019, foreign stocks outperformed Canada by around 4.6% per year. But if you’re old enough, you might remember that from 2000 through 2009, Canadian stocks crushed the rest of the world by an average of 8.1% percentage points per year.
Remember, global diversification is based on the idea that all countries have roughly equal expected returns over the very long term, even if they experience wide variance over shorter periods. Indeed, if you had been invested during the 25 years from 1995 to 2019, it would have made virtually no difference whether you had selected 30% or 25% Canadian stocks. Both portfolios would have delivered virtually identical results: an average return of 7.4% per year, with the same level of volatility.
Bottom line: This one’s a coin flip. The small difference in allocation to Canadian equities will likely have no meaningful impact over the long term.
As we’ve noted, Vanguard allocates 70% of its equity portfolios to foreign stocks, while iShares assigns a weight of 75%. But there are also more important differences between the way these fund providers divvy up this allocation between US, international, and emerging markets equities.
Vanguard assigns a weight to each region based on market capitalization: that is, according to the total dollar value of all publicly listed stocks in each region. For example, today the US comprises about 58.7% of the global stock market, not including Canada. International developed markets make up about 30% of the global market (ignoring Canada), while emerging markets grab the remaining 11.3% or so. The foreign equity allocation in the Vanguard asset allocation ETFs is broken down according to those proportions.
It’s important to stress that these weights are not static: they will change over time as the market caps of various countries evolve.
iShares, by contrast, assigns specific target weights for their US, international, and emerging markets allocations. U.S. equities receive a 60% share of the overall foreign equity allocation in each ETF, with another 33.3% going international developed countries and the remaining 6.7% to emerging markets.
The biggest takeaway here is that the iShares ETFs significantly underweight emerging markets (and overweight developed markets) relative to their Vanguard counterparts. This difference is even greater when you consider that South Korea is considered a developed market by Vanguard’s index provider (FTSE) and an emerging market by iShares’ (MSCI).
Bottom line: If you want your foreign equity allocation to roughly mirror the global stock market, the Vanguard asset allocation ETFs are the way to go. If you prefer to underweight emerging markets, choose the iShares ETFs.
Overall equity asset allocation: Vanguard v. iShares ETFs
|Emerging markets equities||7.9%||5%|
Now, over to the fixed income side of the asset allocation ETFs. Here, too, there are some significant differences between Vanguard and iShares.
The Vanguard fixed income portfolios include 60% Canadian bonds and 40% foreign bonds. The domestic bonds cover the broad market, with government and corporate bonds of all maturities. As with the foreign equity portfolios, Vanguard includes US, international and emerging market bonds, weighted according to each region’s market cap. Currently this works out to approximately 43% US bonds and 57% international and emerging markets.
iShares opts for more Canadian content, with 80% of the fixed income portfolio in domestic bonds. Moreover, iShares also swaps out a portion of the broad-market Canadian bonds for shorter-term corporate bonds. The other 20% is US bonds, split evenly between government and corporate investment-grade issues.
Overall fixed income asset allocation: Vanguard v. iShares ETFs
|Canadian broad market bonds||60%||62.5%|
|Canadian short-term corporate bonds||-||17.5%|
|US broad market bonds||17.2%||-|
|US government bonds||-||10%|
|US corporate bonds||-||10%|
|International broad market bonds||22.8%||-|
Both fund providers hedge all the foreign currency in the bond portfolios (as they should), which reduces the volatility that would otherwise result from changes in exchange rates, making the foreign bonds behave more like Canadian bonds. For this reason, you’re not likely to see big differences in the performance of Canadian and foreign bonds, like you would in equities. So although the Vanguard portfolios have far more non-Canadian bonds that their iShares counterparts, this will likely have only a modest effect on long-term performance.
More significant, perhaps, is that the iShares bond portfolios have a lower average maturity (9.6 years versus 10.4 years for Vanguard’s) and lower duration (7.4 versus 8.1). Lower duration means the bonds are less sensitive to changes in interest rates, so the iShares portfolios might be slightly less volatile. However, the extra helping of corporate bonds also adds a layer of credit risk.
Bottom line: Vanguard’s approach—including all countries in proportions that match their size in the overall market—is much closer to a traditional indexing strategy. iShares makes some active decisions (no overseas bonds, more corporates, shorter duration) that you might not agree with.
Of course, one of the best features of asset allocation ETFs is that they rebalance for you: that means you never need to worry about selling bonds to buy more stocks during a bear market, or doing the opposite after a big run-up in stocks. Here again, though, Vanguard and iShares have different strategies.
We should acknowledge that this is probably a moot point for the foreseeable future. Investors have poured hundreds of millions into these ETFs in the last couple of years. Those huge cash flows have allowed the fund managers to simply buy more of whatever asset class is furthest below its target weight. That prevents the portfolios from ever getting so far out of alignment that the manager needs to sell securities to rebalance.
If those cash flows eventually slow down, however, then the asset allocation ETFs may need to actively rebalance after a big move in the markets. Vanguard’s plan is to prevent any individual holding from drifting off target by more than an absolute two percentage points. For example, VBAL has a Canadian equity target weight of 18%. If this becomes more than 20% or less than 16%, the fund manager would step in to rebalance.
The iShares strategy is a bit different. Their plan is to rebalance anytime an asset class drifts off target by a relative 10%. For example, XBAL’s target for Canadian equities is 15%, so the rebalancing threshold is 1.5 percentage points (because 10% of 15% = 1.5). So the managers rebalance if the allocation to Canadian equities creeps past 16.5% or falls below 13.5%.
Bottom line: The asset allocation ETFs will likely remain very close to their targets at all times, so the differences in rebalancing strategies are likely to be negligible.
Purchase plans at your brokerage
Let’s wrap up by considering some differences between the Vanguard and iShares asset allocation ETFs that are specific to your online brokerage. If you don’t have a strong preference for one of these fund families over the other, these practical considerations might tip the scales.
First, both XBAL and XGRO are eligible for commission-free trades at both Scotia iTRADE and Qtrade. So if you invest through either of these brokerages, opting for these iShares ETFs instead of their Vanguard equivalents (VBAL or VGRO) will significantly reduce your trading costs.
Even if you invest with Questrade, where all ETF purchases are free, the iShares ETFs have one potential advantage: XBAL and XGRO are eligible for pre-authorized cash contributions (PACCs). This program allows you to arrange for a specified dollar amount to be taken from your chequing account and used to purchase ETF shares at regular intervals. While this allows you to put your portfolio management on autopilot, you should be aware that iShares seem to support the program reluctantly (it’s not advertised on the website) and it’s a nuisance to set up. But if you’re interested, contact Questrade’s help desk for instructions.
Bottom line: If you’re making small, regular contributions to your asset allocation ETFs, the iShares versions may offer more opportunities to reduce the commissions you pay. But this consideration should not be the driver of your decision between the two fund providers.