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May 26, 2018

Global Stock and Bond Diversification

This fall, individual investors could be able to use just two exchange-traded funds (ETFs) to diversify both globally and by asset class. The annual expense of such a portfolio will be about one-tenth of a penny per dollar invested, exclusive of any transaction costs.

Vanguard filed a preliminary registration statement with the U.S. Securities and Exchange Commission (SEC) on Monday to launch a global bond fund. The Vanguard Total World Bond ETF will provide exposure to both domestic and foreign investment-grade bonds. The fund giant already has a similar ETF on the equity side, Vanguard Total World Stock (VT) .

This could be a sign of the direction that the biggest ETF providers may be headed in. The plain-vanilla space is already dominated by the likes of SPDR S&P 500 (SPY), Vanguard Total Stock Market (VTI), iShares MSCI EAFE (EFA), PowerShares QQQ (QQQ), etc. Expense ratios have been cut on the largest ETFs and could eventually fall even closer to 0%. The smart beta category is getting crowded on the domestic side, with newer entrants such as Goldman Sachs and AQR Capital Management having already thrown their hats into the ring. Thematic ETFs continue to be rolled out, but have mostly remained in the shallow end of the pool with low levels of both assets and trading activity. Bluntly put, the ETF industry is maturing and, with the possible exception of actively managed funds, the amount of room for new ideas is getting to be rather small.

If approved, Vanguard will be giving investors the option of having a very simplistic approach to diversification. With two ETFs—VT and the proposed global bond fund—investors will be able to create a globally diversified portfolio comprising both stocks and bonds. The only decisions left will be how much to allocate to each fund and how frequently to rebalance the portfolio.

The Vanguard combination won’t be the only option for those who want a simplistic approach to global diversification. The Cambria Global Asset Allocation ETF (GAA) already provides exposure to global stocks, bonds, real estate, commodities and currencies. Like the proposed Vanguard bond ETF, which will invest directly in the Vanguard Total Bond Market ETF (BND) and Vanguard Total International Bond ETF (BNDX), Cambria’s ETF is a fund of funds. It invests in approximately 29 other ETFs (from both Cambria and other ETF providers). The expense ratio is 0.30%. IShares Core Moderate Allocation ETF (AOM) invests in seven other iShares funds and trades with an expense ratio of 0.25%.

You could also create your own globally diversified portfolio by handpicking the funds yourself. A slightly different approach would be to buy individual securities and then fill the desired allocation gaps (e.g., foreign bonds) with specific ETFs, mutual funds or closed-end funds. The decision depends on how much you desire simplicity or control and how much international exposure you want. I have yet to see any consensus on what level of international exposure is appropriate for individual investors.

The Vanguard and iShares funds are market-cap weighted, whereas the Cambria fund uses several alternatively weighted funds. In all cases—and with other asset allocation ETFs and mutual funds (e.g., target date funds)—investors need to be aware of what the underlying funds are investing in to avoid overlap. For example, an investor using the two-fund Vanguard lineup should look toward small-cap stocks, real estate investment trusts (REITs), high-yield (“junk”) bonds and commodities if they have a desire to supplement with additional funds or individual securities.

The Week Ahead

The U.S. financial markets will be closed on Monday, May 28, in observance of Memorial Day.

The earnings calendar lists nine S&P 500 companies: Salesforce.com Inc. (CRM) and HP Inc. (HPQ) on Tuesday; Analog Devices Inc. (ADI), Michael Kors Holdings Ltd. (KORS) and PVH Corp. (PVH) on Wednesday; and Costco Wholesale Corp. (COST), Dollar General Corp. (DG), Dollar Tree Inc. (DLTR) and Ulta Beauty Inc. (ULTA) on Thursday.

The week’s first economic reports will be the March S&P Case-Shiller home price index and the Conference Board’s May consumer confidence survey, released on Tuesday. The May ADP employment report, the first revision to first-quarter GDP, April international trade and the Federal Reserve’s periodic Beige Book will be released on Wednesday. Thursday will feature April personal income and spending, the May Chicago Purchasing Managers Index (PMI) and the April pending home sales index. May motor vehicle sales, the May jobs data (including the change in nonfarm payrolls and the unemployment rate), the May PMI Manufacturing Index, the Institute for Supply Management’s (ISM) May manufacturing index and April construction spending will be released on Friday.

Two Federal Reserve officials will make public appearances: St. Louis president James Bullard on Tuesday and Atlanta president Raphael Bostic on Thursday.

Courtesy of Charles Rotblut, CFA is the VP and Editor for American Association of Individual Investors (AAII). Charles is also the author of Better Good than Lucky. (EconMatters author archive here)     

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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