The steady popularity of asset allocation ETFs is certainly a good thing, perhaps even revolutionary. Canadians have enthusiastically adopted the Vanguard and iShares portfolios, in particular: VGRO alone has $ 1.7 billion in assets. (The smaller family of portfolios with a BMO ETF is also excellent.) For anyone who doesn’t miss out on cart jumping, other fund providers have recently launched their own single fund solutions, including portfolios. of TD One-Click ETFs, which appeared last August.
TD has always had an awkward relationship with indexing. On the one hand, its excellent e-series investment funds now have a history of 20 years, which is an eternity for an index fund in Canada. They are still the cheapest index funds available to DIY investors, which is why they continue to be part of my portfolio model. But TD seems to hold these funds only reluctantly. They were never advertised and until 2019 were only available to TD customers, and even then you often had to jump through flaming hoops to buy them.
It would have been easy for TD to combine the e-series core funds into a low-cost balanced portfolio long before asset allocation ETFs arrived on the scene. But they never did. They approached 2017 and launched a family of five managed ETF portfolios, including, for example, the TD Managed Balanced Growth ETF portfolio. Despite the confusing name, they were actually mutual funds, not ETFs, but they used TD index ETFs as underlying holdings. The press release called them “a new set of all-in-one index solutions,” which looked promising.
Unfortunately, as I pointed out at the time, they are not cheap, with an MER of about 0.78%. Worse, the prospectus gave managers room to change asset allocation “based on market prospects”. It turned out to be even worse: in 2020, managed ETF funds ceased to be index solutions and added a large number of actively managed ETFs.
I mention all of this to provide context for a discussion of TD’s new trio of One-Click ETF portfolios. Like other asset allocation ETFs, they offer investors the opportunity to build a globally diversified portfolio at low cost (the management fee is 0.25%) with a single product. But a closer look reveals that they are much more active than their Vanguard, iShares and BMO counterparts.
At first glance, One-Click ETF portfolios are similar to other asset allocation ETFs in terms of overall asset structure and combination. They include several underlying ETFs covering Canadian, US and international equities, although a notable difference is that TD portfolios do not include emerging markets. There is also a mix of good Canadian and American.
The main basic elements are the same four ETFs that make up the underlying holdings in the e-series funds:
So far, so good. But remember when we said TD has never fully adopted indexing? Well, unlike Vanguard, iShares, and BMO asset allocation ETFs, One-Click portfolios include more than traditional index funds. Much more, actually. Although the marketing material states that around 75% of the portfolios are built from “low cost and broad market index” ETFs, we are concerned.
One of the most important equity holdings is the TD Global Technology Leaders Index ETF (TEC), which technically tracks an index, but is certainly not a broad market ETF: it is a concentrated bet for the global technology sector, with large stakes in Apple, Microsoft, Amazon, Facebook, Tesla and Alphabet.
You’ll also get help from the TD Q Global Multifactor ETF (TQGM), which “uses a quantitative stock selection strategy combined with an optimized portfolio building process,” whatever that means.
And there are more: the TD Q Global Dividend ETF (TQGD), the TD Q US Small-Mid-Cap Equity ETF (TDQSM) ETF and the Canadian Low Volatility TD Q ETF (TCLV). I haven’t seen so many Q’s since Peter Griffin was on the wheel of fortune.
In terms of fixed income, part of the bond exposure comes from index funds, but again, portfolios are much more active than traditional asset allocation ETFs. There are up to five actively managed bond ETFs, including three that have high-yield bonds, which are much more risky than the investor-quality bonds you’ll find in the Vanguard, iShares, and BMO funds.
And, to top it all off, there are American bonds without currency hedging, which means you’ll be exposed to the exchange rate between the U.S. and Canadian dollars. Remember that bonds are supposed to reduce the volatility of your portfolio, but adding foreign bonds without coverage is more likely to increase.
As expected, TD markets these actively managed components as an improvement on traditional indexing: “What makes One-Click TD ETF portfolios unique is the allocation to approximately 25% of active ETFs and how much. Normally, all-in-one ETFs have 100% passive ingredients, which means that with TD you will get more professional management. “
This is consistent with what TD has done with the managed ETF portfolios we discussed earlier. Clearly, they are trying to differentiate their one-click ETF portfolios from the competition, moving away from indexing and promoting the skill of their portfolio managers.
A weight problem
Now that we’ve reviewed the underlying holdings of the one-click ETF portfolios, let’s consider how they are assembled. The following is how the TD website broken down each fund by asset class at the end of January:
Source: TD Asset Management as of January 29, 2021
Here are some things. The first is the inconsistency between the three funds. In Vanguard and iShares asset allocation ETFs, the relative weighting of Canadian and foreign equities is the same across the family. For example, in the five iShares funds, Canadian equities account for 25% of the equity allocation, while U.S. equities account for 45% and international and emerging market shares account for the other 30 %.
In contrast, the relative proportions differ between the three TD funds. Note that TOCC has much less in Canadian equities than international equities (8% versus 12.9%), while TOCA has more (27.6% in Canadian equities and only 25.2% internationally). At TOCC and TOCM, approximately three-quarters of the bonds are Canadian, while at TOCA there are none.
It’s one thing to promote the skill of fund managers, but it’s hard to understand why they would apply their convictions differently. Why overweight one asset class in one fund and underweight it in another? It is to be expected that these portfolios will be the same in all respects except the global combination of stocks and bonds.
A changing mix of assets
We are not done yet. The Vanguard, iShares, and BMO asset allocation ETFs have specific long-term goals for stocks and bonds and clear rules about how often these targets will be rebalanced. If you buy VBAL, for example, you can be confident that the ETF will always stay very close to its target of 60% equities and 40% bonds.
Not so with single-click ETF portfolios. TD’s literature specifically states that asset weights “may change due to market movements and the discretion of the portfolio manager” and that the fund “may also hold a significant portion of its assets in cash equivalent instruments when the ‘portfolio advisor believes it is prudent to do so’.
You can already see these portfolios deviating from their goals. TOCM, which has the same 60/40 benchmark allocation as VBAL, currently has less than 32% in bonds. Similarly, TOCC has a 70% bond benchmark, but its current allocation is just over 60%. And TOCA, with a benchmark index of 10% of bonds, only has half of them.
This strategy (called tactical asset allocation) is common in active funds, but has a similar trajectory to other forms of active management: it has an intuitive appeal, works sometimes, but usually does not provide better risk-adjusted returns. than a boring old index portfolio that automatically rebalances each time an asset class deviates by more than a few percentage points.
We take a step back and remember Because the Vanguard, iShares and BMO asset allocation ETFs are such excellent products. Yes, they are very diverse, economical and convenient. But their other key advantage is that they are built entirely from index funds.
In contrast, One-Click TD ETF portfolios use two layers of active management, with unindexed holdings and tactical asset allocation. They may outperform some periods, and if you believe in the so-called core and satellite strategy that combines passive and active components, these TD ETFs are a low-cost and well-diversified way to achieve this.
However, if you’re looking for normal vanilla index funds — which are all I’ve ever included in my model portfolios — TD’s One-Click ETF portfolios just don’t fit that description.
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