Asset allocation ETF

An asset allocation ETF (exchange-traded fund) is the ETF equivalent to balanced mutual fund. They combine equities (stocks) with bonds in a single, one-fund portfolio. The asset allocation varies for each product, with well established funds including "all-equity", "growth" (80% equities) "balanced" (60% equities), "conservative" (40% equities) and "income" (20% equities) profiles. The stock and bond components are diversified by geography, i.e. the asset allocation ETFs offer global diversification.

These ETFs are sometimes known as balanced ETFs and invest in several other ETFs from the same providers to build up complete portfolios containing thousands of stocks and bonds. The constituent ETFs are passively managed; more specifically they are capitalization-weighted index ETFs. Asset allocation ETFs are rebalanced by the providers to keep the asset allocation in line with the policy of the funds.

The management fees on asset allocation ETFs are about 0.2%, much cheaper than any other one fund solution in Canada, and cheaper than robo-advisors. Investors only pay the management expense ratio (MER) of the balanced ETFs, not that of the underlying funds, i.e. there is no "double-dipping".

Well established funds
As of September 2021, eleven such ETFs are available on the Toronto Stock Exchange (TSX), have been around for over a year, have over $50M in assets, and are regularly discussed on the Financial Wisdom Forum:

The directly competing Vanguard, Ishares and BMO products offer the same overall stock:bond split. For example, VBAL, XBAL and ZBAL all contain 60% equities and 40% bonds. Vanguard, Ishares and BMO will hedge the currency exposure of foreign bonds, but not of foreign stocks.

Where they differ is on how the stocks and bonds are allocated by geography. Here is how the Vanguard and Ishares products compared as of January 2019:


 * for stocks, the Vanguard products have a slightly higher home country bias, with 30% domestic and 70% foreign content, versus 25/75 at Ishares
 * the proportion of US stocks is greater in the Ishares products
 * for bonds, the Vanguard products have more foreign content (60% domestic/40% foreign) than the Ishares ones (80/20)
 * the Ishares ETFs have no international (developed ex-US) bonds
 * Ishares overweights corporate bonds, whereas Vanguard does not

Despite these differences, backtesting by Justin Bender indicates the competing products from Vanguard and Ishares would have performed very similarly over a 20 year period.

Vanguard has indicated that the home bias of their asset allocation ETFs may decrease over time. The ex-Canada stocks and bonds will be allocated according to market weights.

New funds
The asset allocation ETF category is growing rapidly.

On February 15, 2019, BMO also launched :
 * BMO Conservative ETF (ZCON): 40% equity and 60% fixed income

In August 2019, Ishares launched:
 * iShares Core Income Balanced ETF Portfolio (XINC): 20% equity and 80% fixed income

These products have the potential to make it to the "well-established" list above, but are too recent and/or have not gathered $50M or more yet.

For other recent offerings, the general advice on the FWF is to wait a year or so to invest in any new ETF, to see if the new product gathers assets and trading volume.

ESG funds
Investors concerned about environmental, social and governance (ESG) issues have options in the asset allocation ETF space. This includes:
 * BMO Balanced ESG ETF (ZESG)
 * Four offerings from Ishares, with equity proportions from 40% to 100%

These ETFs differ significantly from mainstream asset allocation ETFs in several respects, such as percentages of equity regions, equity sector percentages, number of stocks included (diversification), and type of fixed income.

See the ESG portfolio screening article for a general discussion about ESG investing.

Advantages

 * Ultimate simplicity
 * Behavioral benefits:
 * 1) the volatility of balanced ETFs is less than that of most of the underlying components, helping nervous investors stay invested during equity bear markets ;
 * 2) enforces discipline by preventing investors from tweaking their portfolios in reaction to the news
 * No rebalancing needed
 * Reduce the number of trades
 * Buy a single fund across all accounts (if desired)



Drawbacks

 * MER will be slightly higher than the weighted average of the constituent ETFs, for example the Vanguard products cost 5 to 7 basis points more than the underlying ETFs
 * Not as tax-effective as simple index portfolios consisting of 3-5 ETFs, if using multiple accounts
 * Except for XBAL and XGRO, no pre-authorized contributions and automatically reinvested distributions (as opposed to what is possible for mutual funds), although some discount brokers might offer to reinvest distributions

Usage and suitability
Asset allocation ETFs have the same potential uses as balanced mutual funds, and more. With the wide ranges of asset mixes now available, they can suit investors with very diverse risk profiles, ages or portfolio sizes.

New investors and small accounts

 * Ideal for novice investors
 * Ideal for small accounts, including registered ones (such as Registered Retirement Savings Plans, Tax-Free Savings Accounts, or Registered Education Savings Plans)

Larger accounts and more experienced investors

 * Also appropriate for larger accounts, if the advantages listed above are thought to outweigh the drawbacks
 * Simplify the portfolios of older investors who are concerned about potentially becoming cognitively impaired in the future, or are losing interest in portfolio management
 * Interesting option for non-registered accounts that might eventually be transferred to a spouse at cost (see Death and taxes: spousal rollovers)

Initial implementation

 * 1) Open an account at a discount brokerage, if not already done
 * 2) Select one of the well established ETFs listed above based on your desired asset allocation (see also portfolio design and construction, and investment policy statement). Online questionnaires such as Vanguard's may help.
 * 3) Calculate how many whole units you can buy with currently available funds, based on the current ask price (when doing the calculation, don't forget to subtract the commission from available funds first)
 * 4) Enter a limit order at the ask price (or a few cents above)
 * 5) Check that your order has been filled
 * 6) If using a non-registered account, record your initial adjusted cost base for tax purposes

How to handle distributions and new contributions
ETFs pay their distributions in cash, not in additional units. Therefore, cash will accumulate into the brokerage account and will need to be reinvested to avoid creating a drag on returns over the long term. Also, new funds will periodically become available to contribute to the account, if the investor is in accumulation mode. There are several (non-mutually exclusive) strategies to handle these distributions and new contributions in a way that minimizes trade commissions:
 * Use a brokerage that does not charge commissions to purchase ETFs
 * Wait until available cash is enough that the commission will be less than 0.5-1% of the amount of the new purchase
 * In the mean time, cash can be parked in a fund-based investment savings account
 * Use a synthetic dividend reinvestment plan (DRIP) if offered by the broker

Articles and blog posts

 * Vanguard, iShares or BMO? A side-by-side comparison of the new all-in-one diversified ETF portfolios, The Globe and Mail, February 2019
 * Vos placements en formule tout inclus (Stéphanie Grammond, La Presse, March 10, 2019)
 * Choosing your ideal Vanguard asset allocation ETF, Canadian Portfolio Manager blog, August 29, 2019
 * Home bias in the Vanguard asset allocation ETFs, Canadian Portfolio Manager blog, August 20, 2019
 * How to set up a hands-off ETF portfolio (addresses asset allocation ETFs), Canadian Couch Potato blog, February 2020
 * Asset Allocation ETF Showdown: Vanguard vs. iShares, Canadian Couch Potato blog, December 2020
 * Inside the iShares ESG Asset Allocation ETFs, Canadian Couch Potato blog, Nov. 2020
 * Inside the BMO Asset Allocation ETFs, Canadian Couch Potato blog, January 2021

Videos

 * Asset Allocation ETFs: Vanguard vs. iShares (VBAL, VGRO, VEQT, XBAL, XGRO, XEQT), Justin & Shannon Bender youtube channel
 * Asset Allocation ETFs: BMO vs iShares (ZCON, ZBAL, ZGRO), Justin & Shannon Bender youtube channel
 * How to Choose Your Asset Allocation ETF, Justin & Shannon Bender youtube channel
 * Sustainable Investing with the iShares ESG ETF Portfolios, Justin & Shannon Bender youtube channel