Model portfolios for ETF investors

Some investors aren’t convinced fees associated with actively managed mutual funds are worth it and opt for portfolios built exclusively with exchange-traded funds.

And the proliferation of sector-specific and other specialty ETFs means advisors can construct portfolios that capture more than just index returns.

To illustrate, the team at Wickham Investment Counsel Inc. in Hamilton, Ont., takes three common client types and shows how to tailor ETF portfolios to their objectives and risk profiles.

Figure 1 Conservative

First, a conservative asset mix (40% equity, 60% fixed income) for a 62 year old with a $1 million portfolio. This is likely enough capital to fund retirement, says Sean Pugliese, associate portfolio manager at Wickham. “His primary goal is to generate income to live on. His secondary goal is to preserve some capital. He also wants inflation protection and a little bit of growth. And that’s the reason for the equities: they’ll preserve his purchasing power over time.”

Figure 2 Balanced

Second, a 50 year old with $500,000 will have a classic 60% equity, 40% fixed-income mix. One reason, says Pugliese, is this investor has 10 to 20 working years left. “She has a pretty large portfolio and she’d probably like to increase it a little bit. At the same time, she probably doesn’t want to put too much money at risk. So she would have a goal of about an equal blend between income and growth.”

Figure 3 Aggressive

Finally, a 35 year old with $250,000 has the most aggressive mix: 80% equity, 20% fixed income. This investor has many working years ahead of him, and high risk tolerance. If markets hit a rough patch, he has plenty of time to recover.

“Growth is the idea behind the 80% equity allocation,” notes Pugliese. “And we sprinkle in some fixed income to generate a little bit of income, reduce volatility and give him a little bit of diversification.”

All three portfolios have many ETFs in common; the main difference is how much weight they get. For instance, the BMO S&P/TSX Laddered Preferred ETF (ZPR) has a 10% share of the aggressive portfolio’s 20% fixed-income allocation, while in the conservative portfolio it takes up 20% of a 60% fixed-income allocation.

Michael Bowman, portfolio manager, notes this five-year laddered holding qualifies for the dividend tax credit if it’s held in a non-registered account.

Another key difference is the iShares S&P TSX Global Gold Index Fund: it appears in the balanced and aggressive portfolios, but not the conservative because it’s too volatile for these clients. Allan Meyer, portfolio manager at Wickham, notes it’s a tactical position that can be removed (and replaced with an ETF that provides similar growth later on) once it hits the team’s target price.

Another tactical holding is the BMO Equal Weight REITs Index (ZRE), which appears in all three portfolios. “We see it as an opportunity at this point because real estate stocks look like they’re bouncing back from being oversold. But it’s a position that can be swapped out fairly quickly.”

Fixed-income holdings have shorter maturities on average, adds Meyer, to minimize the effect of rising interest rates.

Rob Belanger, financial analyst at Wickham, notes yield (as distinguished from total return) is highest in the conservative portfolio, at around 4% to 4.5%.

Adds Pugliese: “That’s the highest yielding portfolio because income is a primary goal. The balanced portfolio is the next-highest yielding because income is a concern, but not as much as in the conservative case. In the aggressive portfolio income is not much of a concern due to the investor’s long time horizon—it’s secondary or tertiary, so that would be the lowest yielding.”