The benefits of a straightforward, diversified, and low cost approach
Multi-asset investing does not need to be complicated. In our view, a straightforward, diversified, low cost approach, should serve a variety of investors well.
We like to think of our Vanguard LifeStrategy Funds, for example, as an outwardly simple but inwardly sophisticated solution. There is a significant level of diversification in the funds given their construction with market-cap weighted index funds. If you look at the 60/40 Fund, made up of 60% global equities and 40% global fixed income, it includes 25 asset classes, including emerging markets and small cap equities.
The passive funds also help keep costs down, which are one of the few levers in the investor's control. Given the inverse relationship between costs and returns, lower costs should translate into higher returns over time. Costs are also one of the few things in investor's control. Of course, we also need to bear in mind that the value of investments can fall as well as rise and investors may not get back all of what they invest.
Perspective on two popular alternative asset classes
In today's low yield environment, we are often asked about the inclusion of commercial property and other alternative asset classes as a substitute for fixed income. It's important to remember that commercial property has much different risk characteristics than bonds and there is no liquid, publicly traded market for this type of asset. Property values are only updated on an annual basis through appraisal, distorting their reported correlations, and experience suggests they will not offer the same levels of diversification during periods of market stress.
Commodities are another 'alternative' asset class we are often asked about that also cannot be invested in directly. Exposure is typically obtained through futures markets. They are liquid, publicly traded, but a future does not have a cash flow and can't be valued in the same way as equities and bonds. Instead, valued are obtained by other facts such as supply and demand and the time to maturity, making their prices more volatile. Correlations of commodities and traditional asset classes have also risen significantly over time, potentially reducing their diversification benefits.
Finally, our research shows that to make any real difference, investors need to allocate around 10% or more of a given asset class to their portfolio. This suggests significant commitment and requires you to underweight another asset class.
There are pros and cons to every investment decision, but in our view, a straightforward, well-diversified portfolio of equities and bonds, implemented at a low cost, should work well for a variety of investors.
|Asset allocation name||Attitude to Risk||Risk Rating|
|Vanguard LifeStrategy 40%||Balanced||3.3|
|Vanguard LifeStrategy 60%||Moderately Adventurous||4.1|
|Vanguard LifeStrategy 80%||Adventurous||5.1|
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