The launch of two excellent new diversified exchange traded funds (ETFs) by Vanguard is a great reminder that ETFs are not a simple set and forget investment.
Whenever adding an ETF to an investment portfolio it is important to consider the sort of overlap it might have with other ETFs already in your portfolio and make adjustments when needed.
The new funds, Vanguard diversified all growth index ETF (ASX: VDAL) and Vanguard diversified income ETF (ASX: VDIF) are well worth considering but only in the context how many gaps there are that you need to cover.
Financial planners often notice that Australians who have invested in exchange traded funds hold double-ups, which means they could be paying unnecessary fees to get the same exposure.
This is particularly the case of pure index funds such as those covering the ASX200 or the S&P 500.
A recent analysis of 71,730 investors’ portfolios by portfolio tracking tool Sharesight showed that of those invested in Vanguard’s ASX300 ETF (ASX: VAS), which tracks the ASX300, 6.5% had also invested in Betashares A200 ETF (ASX: A200) which tracks the ASX200).
A further 3.7% were also invested in iShares’ ASX200 ETF (ASX: IOZ) and 1% were invested in all three.
That means about one in ten investors in Australia’s biggest ETF is also invested in a near-identical product.
The situation was similar in ETFs that cover the US market, with many investors holding a S&P 500 ETF such as Vanguard’s ASX: VOO and a NASDAQ ETF such as Betashares ASX: NDQ perhaps without realising the extent of the double up between those two.
That concentration has only increased with the dominance of the technology giants across both US indices.
They may be some very good reasons for such a double up with many ETF investors not wanting to generate a capital gain by selling off a long-standing ETF holding even if they’re buying a new ETF which may have lower fees.
That could mean that they funnel all of their new investments into the cheapest ETF but still hang on to an earlier ETF purchase that may have had a lower management cost but has now been overtaken.
In general, though, it’s not a good idea to buy multiple ETFs that offer the same or very similar coverage because it limits diversification or perhaps creates a misleading illusion of diversification and increases fees.
Now to get back to the new Vanguard ETFs and see what lies under the hood.
In the case of the Vanguard Diversified All Growth Index ETF (ASX: VDAL), it is designed for investors with a very high-risk tolerance seeking long-term capital growth.
It gives total exposure to an amazing 6,000 or even more companies across the world offering growth including Australian equities, global equities, emerging markets and global small caps.
That could certainly suit some investors who want exposure to global growth stocks in one neat package and all for a reasonable management fee of 0.27% a year.
The Vanguard Diversified Income ETF (ASX: VDIF) is designed to suit investors looking for regular income with some capital growth potential, blending investment grade fixed income, corporate bonds, and high dividend yield equities.
VDIF is highly diversified, with exposure to more than 12,000 securities, allocating 40% to defensive assets and 60% to growth assets, all for a management fee of 0.32% a year.
One of the best ways to think of ETFs is as a core holding so it is a good idea to only have a small number of core holdings, such as one covering the Australian ASX 200, another covering the S&P 500 and another covering major international share markets.
Other ETFs might still find their way into your portfolio as satellite investments covering areas such as fixed interest, specialised areas or bonds but the core holding should remain quite simple and easy to understand.
Holding too many overlapping ETFs can cause unwanted duplication, higher fees, and may give investors an unrealistic picture of their actual diversification which may only emerge when markets turn bearish.
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