In our last blog and video, Justin and I compared the popular Vanguard and iShares asset allocation ETFs, both of which are options in our model portfolios. But although these two fund families get all the attention, BMO offers a trio of asset allocation ETFs that deserve your attention as well. So here’s our long overdue review of these portfolios.
In much of what follows, we’re going to hold up BMO’s asset allocation ETFs against their iShares counterparts, since the two families have a lot in common and provide a useful apples-to-apples comparison.
BMO’s asset allocation ETFs appeared in February 2019, about two months after those of iShares, and about a year after Vanguard pioneered the one-ETF portfolio in Canada. Rather than running the gamut from ultra-conservative to hyper-aggressive, BMO’s family covers only the middle ground, with three balanced portfolios of 40%, 60% and 80% equities. That makes sense, given that the latter two are the most popular with investors.
|Asset Mix||BMO Asset Allocation ETF|
|40% equities / 60% bonds||BMO Conservative ETF (ZCON)|
|60% equities / 40% bonds||BMO Balanced ETF (ZBAL)|
|80% equities / 20% bonds||BMO Growth ETF (ZGRO)|
Like the iShares portfolios, each BMO fund includes several underlying ETFs that in turn hold thousands of global stocks, as well as Canadian and US bonds. BMO’s fees are also competitive, with MERs of 0.20%. (Remember, with all asset allocation ETFs, the fees of the underlying holdings are rebated, so the published MER is all you pay. There is no double-dipping.)
All right, let’s take a deep dive into how the BMO asset allocation ETFs are constructed.
As you might expect, the BMO portfolios include equity ETFs covering Canada and the US, as well as international developed and emerging markets.
Like iShares, BMO allocates 25% of its equity mix to Canadian stocks, and another 25% to international developed markets. However, the two fund providers differ in their allocation to US and emerging markets. US stocks make up between 40% and 41.25% in BMO’s portfolios, compared with the 45% slice in the iShares ETFs. Emerging markets stocks round out the rest: BMO allocates between 8.75% to 10%, while iShares includes just 5%.
There’s another important difference between the BMO and iShares equity portfolios. If you’re familiar with BMO’s lineup, you’ll know their flagship US equity ETF tracks the S&P 500, which includes only large-cap stocks, and their international equity ETFs track MSCI indexes that include large and mid-cap stocks only. iShares, by comparison, offers “total market” ETFs that include thousands of additional small-cap stocks. These differences naturally show up in the BMO and iShares asset allocation ETFs, too.
We tend to prefer total market indexes and we’d agree the S&P 500, in particular, is not an ideal benchmark (its constituents are not just the 500 largest stocks in the US: they’re chosen by a committee based on some idiosyncratic rules). But for what it’s worth, the presence or absence of small-cap stocks in these indexes had virtually zero effect on performance over the last 25 years.
Remember that in cap-weighted indexes larger stocks dominate: a few huge companies can have significantly more impact than thousands of smaller ones. The companies in the S&P 500 make up about 80% of the US market, for example, while the other 3,200 or combine for just 20%. Small-cap stocks have even less impact in international and emerging markets.
As a result, from 1995 through 2019, both the BMO and iShares equity portfolios would have enjoyed virtually identical results: an annualized return of 8.2% with a standard deviation—a measure of volatility—of 11.7%. (Justin ran this comparison using index data, with the same allocations as the BMO and iShares ETFs, rebalanced quarterly.)
The BMO asset allocation ETFs have the most Canadian content on the bond side: they target 90% domestic bonds. The lion’s share is carried by BMO Aggregate Bond Index ETF (ZAG), which tracks the broad Canadian bond market, including government and corporate bonds of all maturities. However, BMO also adds a helping of the BMO Government Bond Index ETF (ZGB), so it has a slightly greater tilt toward government bonds than the iShares portfolios.
The remaining 10% of the fixed income allocation goes to US bonds: specifically, mid-term (five to 10 years to maturity), investment-grade corporates, hedged to the Canadian dollar. iShares, by comparison, has twice as much in US bonds, and these are split evenly between government and corporate issues.
The BMO bond portfolios have an average maturity of 10.7 years and a duration of 8.3 years, compared with 9.6 and 7.4 years, respectively, for the iShares ETFs. This means the BMO funds will be more sensitive to changes in interest rates, and therefore slightly more volatile. However, the greater share of government bonds also decreases the credit risk.
BMO Asset Allocation ETFs: Overall equity and fixed income mix
|Asset class||Underlying ETF||ZCON||ZBAL||ZGRO|
|Emerging markets equities||ZEM||4%||5%||7%|
|Canadian broad market bonds||ZAG||42%||28%||14%|
|Canadian government bonds||ZGB||12%||8%||4%|
|US mid-term corporate bonds||ZMU||6%||4%||2%|
Source: BMO ETFs
Let’s wrap up by looking at how the BMO asset allocation ETFs maintain their long-term targets.
BMO plans to review their portfolios quarterly and rebalance any holding that has drifted by 2.5 percentage points from its target weight. For example, the BMO Balanced ETF (ZBAL) has a long-term target of 15% for Canadian equities, so it will rebalance if this asset class increases to 17.5% or falls to 12.5%
As we saw in our last post, iShares plans to rebalance anytime an asset class drifts off target by a relative 10%. In other words, if the target is 15%, the manager would rebalance if the asset class grew to 16.5% or fell to 13.5%.
However, in practice, BMO will use new cash flows to top up any underweight asset classes, and this should reduce the need to rebalance by selling its underlying holdings. This is good news for investors who hold these funds in non-registered accounts, since selling holdings with gains could be taxable to the ETF’s unitholders.
By now you’ve probably figured out that the BMO asset allocation ETFs would be an excellent choice for index investors seeking a globally balanced portfolio in a single fund. Over the long term, they should be expected to deliver very similar performance to their Vanguard and iShares counterparts, as the strategies are largely the same.
I’m often asked why I haven’t included the BMO asset allocation ETFs in my model portfolios. It’s certainly not because they’re inferior products: it’s simply that BMO’s family of funds is less complete, with no 100% equity option (the equivalent of VEQT or XEQT) that can be combined with a bond fund to customize your asset mix. But if you prefer BMO’s strategies and your target matches one of their three available options, it would be hard to go wrong with these well designed, well diversified one-fund solutions.