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 |
100% equities | VEQT | XEQT |
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.
Canadian equities
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.
Foreign equities
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
Asset Class | Vanguard | iShares |
---|---|---|
Canadian equities | 30% | 25% |
US equities | 41.1% | 45% |
International equities | 21% | 25% |
Emerging markets equities | 7.9% | 5% |
100% | 100% |
Fixed income
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
Vanguard | iShares | |
---|---|---|
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% | - |
100% | 100% |
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.
Rebalancing strategies
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.
Hi Dan- I currently have a financial advisor with a brokerage firm whom I’m not happy with due to lack of communication. My portfolio is mainly in RRSP and RRIF accounts. 65% of the holdings are in U.S. stocks and some international stocks. The remaining holdings are in Canadian stocks and fixed income. I’m thinking of leaving my advisor and starting an ETF portfolio. I want to buy XBB/ZST and ZCN for the fixed income and Canadian equity portion of my portfolio. Im considering buying XAW or VXC for the US and international portion however XAW and VXC are priced in Canadian dollars. I don’t want to sell my US stocks and convert the funds to cdn$ since these stocks were purchased when the US dollar was over 1.38 cdn. Another option is to purchase the US equivalent of XAW or VXC ( is it possible to recommend a couple of global funds in US dollars ). Do you think I’m on the right track or do you recommend other options. I’m over 65 and retired. Thank you so much.
@Paul H: Thanks for the comment. If you want to to keep your foreign equities in USD, there are a couple of US-listed ETFs that are similar to VXC and XAW. Both include a small allocation to Canada as well, but it’s less than 3% so you can ignore it. Have a look at Vanguard’s VT.
That said, selling US stocks and then purchasing a CAD-denominated ETF that holds US stocks actually does not change your currency exposure. Your exposure comes from the underlying stocks, not the currency of the ETF. This is a very common misunderstanding:
https://canadiancouchpotato.com/2014/01/13/how-a-falling-loonie-affects-us-equity-etfs/
Hi Dan. I am looking at the fee required to pay when purchasing an ETF. Example, for VSP, the management fee and MER is 0.08% and 0.09% respectively. Does that mean the total fee I require to pay is 0.17% ? Thank you so much.
@Michael Mok: No the MER includesthe management fee, plus taxes and sometimes a basis point or two in other costs.
Hi Dan, I’m opening an RDSP for my 10 year old son, and I’m having a hard time figuring out where to go – CIBC is my main FI and they shoehorn all RDSP accounts into their MFs which are costly and annoying as they don’t have an overall market VBAL or VGRO substitute which would be my ideal structure at lowest possible cost. Most FIs have “Make an appointment” to learn about options, very limited above-line marketing.
Based on what I’ve said, any advice in terms of where I’m likely to find RDSP options that will meet my needs? Thanks! RIco
@Rick: My understanding is that TD Direct is one of the few online brokerages that offer self-directed RDSPs, which would allow you to use ETFs:
https://www.td.com/ca/products-services/investing/td-direct-investing/accounts/rdsp/
I currently own VGRO in my LIRA account and after seeing this analysis, I’m thinking to sell all $211,000K , then purchasing XGRO I’m in my early 60’s and will be withdrawing funds in the next 2-3 years. Would you suggest purchasing in one lump sum, or in increments?
@michelle: If you are all invested in VGRO, then switching to XGRO is a very subtle change. There is no benefit to doing it gradually. Just switch one for the other. (But, honestly, I don’t see any reason to do so, as the funds are extremely similar.)
More important is whether a portfolio of 80% stocks is appropriate for someone in their 60s and planning to start withdrawals in 2 to 3 years. VGRO/XGRO are very aggressive portfolios that could easily lose over 30% in a sharp downturn. They are more appropriate for investors with a time horizon of over 10 years.
https://canadiancouchpotato.com/2010/11/10/ready-willing-and-able-to-take-risk/
Hi there Dan. The idea of PACC with the iShares ETF’s sounds appealing but I’m leaning towards the Vanguard ETF’s. VGRO in particular. I plan on opening a Questrade account and purchasing through them. I will have about $1350 a month to invest, and when I had a look yesterday VGRO was at 29.88 per share. This would mean I could buy 42.18 shares. But, I can’t buy partial shares so, I would buy 42 shares and then what would happen to the extra $5.40 in this case?
@Nick: If you were using a PAC, they would just purchase 42 shares for you and the remaining $5.40 would just become part of your cash balance. The principal is the same as what happens if you use a DRIP: you receive the maximum number of full shares and the “change” is received in cash.
Hi,
Can you tell me your thoughts on VEQT/VFV portfolio? Is it worth keeping this given there is so much overlap? Historically, VFV really performed well and it’s been doing so well with a very low MER fee. My monthly investment is $400 per month for the next 5-10 years. I am worried VEQT might not perform as good as VFV since it does not enough past data to back it up.
@Shajedul: It’s very important to understand what index funds are so you don’t think of them simply as products. VEQT itself has a short history, but it’s simply a fund that tracks the entire global stock market, which has been around for some time. VFV tracks the S&P 500, an index of large-cap US stocks. So rather than comparing VEQT to VFV, the question should be, “Do you think large-cap US stocks should be expected to outperform the global market during your investment lifetime?” It has certainly done so in the recent past, but I would suggest that global diversification makes more sense than concentrating on a single country.