Shani Jayamanne: Welcome to another episode of investing compass. Before we begin, a quick note that the information contained in this podcast is general in nature, it does not take into consideration your personal situation, circumstances or needs.

Mark LaMonica: So Shani, before we started this episode we were both trying to… give ourselves a little bit of energy to get through this because I feel like we’re both dragging today.

Jayamanne: Yeah.

LaMonica: And part of that is, well I guess to go back, we’ve been going to the gym together.

Jayamanne: We have yeah, we’ve been doing a class called BodyPump, which is…

LaMonica: It’s very embarrassing by the way.

Jayamanne: It is, they play music to get you through 1000 reps in 45 or 55 minutes.

With this like strange little bar thing that you, you know you get to choose what weights you put on it but yeah anyway, well this week I don’t know those two classes this week were really bad.

Jayamanne: They were, they were really bad.

LaMonica: There’s this woman, so we generally go Monday, Wednesday, Friday – on Monday there’s this woman instructor who’s crazy and yells at us.

Jayamanne: What if she listens to this? She’s not going to be listening to this.

LaMonica: She’s not going to be listening to this, and we didn’t say which gym.

Jayamanne: No.

LaMonica: So there’s probably a lot of crazy female instructors that teach classes on Monday in Australia and then yeah, the Wednesday guy, that’s probably my favourite one.

Jayamanne: Okay.

LaMonica: I feel like he takes us, takes it, a little bit easy and then the guy on Friday makes fun of us cause we hide at the back of the room

Jayamanne: We have a spot.

LaMonica: Exactly.

Jayamanne: It’s behind a pole so no one can see us.

LaMonica: It’s right by the door too so we can, we can escape if we want.

Jayamanne: Anyway, what are we going to be talking about today, Mark?

LaMonica: Okay so we’re going to answer the question - can I create a portfolio with one trade?

Jayamanne: There are some investors that enjoy the deep dive into financial reports, revel in the anticipation for earnings season and have excel spreadsheets they visit multiple times a day. There are others that understand it is a necessary action to protect and grow their wealth and just want to be told what to do.

LaMonica: The good thing about capitalism is that it caters to consumer demands and wants. We’ve seen different investment products pop up in the recent past that cater to the crowd that want to invest but want to outsource most of the process. Micro-investing apps, model portfolios, diversified ETFs – these are some of the solutions that the financial products industry have created. In May of 2022, there were 1.8 million Aussies using micro-investing apps that offer ready made portfolios for investors, depending on the risk/return profile they are after. There is demand for simplicity.

Jayamanne: There are many investors who do not enjoy the process of investing but love the outcome. This is not always new investors but may be seasoned investors that are transitioning into retirement that want to spend less time maintaining their portfolios.

LaMonica: Regardless of which camp you sit in, there is something to be said for a simplified portfolio. Over monitoring and trading can lead to detrimental outcomes to investor’s portfolios. We’ve seen this through our ‘Mind the Gap’ study, that looks at the difference between investment and investor returns.

Jayamanne: This study has been conducted since 2010, quantifying this impact of investor behaviour on investment returns. There are a few insights from this study – more volatile funds had larger gaps – and this correlation makes sense. When there’s volatility, it causes fear and nervousness in investors, and leads to redemptions.

LaMonica: Another insight is generally, big pivot years for the markets lead to the worst timing. What this means is that investors sell after a bear market and buy after a bull market – even though one of the most well-known investing adages is buy low, sell high. We all know this, but in practice it’s very different when emotions come into play.This played out during the GFC for US investors, where the gap widened even further – we saw a lot of panic selling at the bottom, missing out on a dramatic rebound.

Jayamanne: So, what was the actual gap? The gap between investor return and investment return was 2% in equities-based funds and 1.44% in alternative funds. So the lesson we can glean from this is that over the long term, switching in and out of funds and investments is usually to your detriment.

LaMonica: Another large consideration is fees. Many of these model portfolios and investing apps come at a cost. Flat administration fees and management fees are placed on top of the fees of the underlying investment products. The result of fees on top of fees is poor outcomes for investors.

Jayamanne: So Mark, in an age where many Australians are looking to invest, but a growing number have no interest in the art – is there an answer?

LaMonica: Like everything to do with investing, it is not clear-cut. Investors who do not want to build a portfolio from scratch must walk a tightrope between scalable investment solutions and portfolios customised for their goals. Adding to this, the complication of managing a suitable asset allocation strategy within the constraints of investment amounts and brokerage, especially with smaller balances. You don’t want to end up in a situation where you’re investing $500 a month across 5 ETFs and 3 equities. Ultimately, every investor’s situation is unique, and there’s no one size fits all answer.

Jayamanne: This does not mean that there aren’t ways to simplify investing.

LaMonica: Constructing a portfolio can be broken into blocks, instead of individually seeking out exposure to asset classes. As a cook, this would be the equivalent of pasta sauce from a jar, but adding depth with sofrito, and salt and pepper (and maybe chilli) to your liking.

Jayamanne: The technical term for this is a core-satellite portfolio, but this strategy was theorised way before the investment industry evolved to offer retail investors so many multi-asset options. Core-satellite portfolios revolve around the premise that passive investments can do most of the heavy lifting, and they are to make up the ‘core’ of your portfolio. The ‘satellite’ is where you concentrate exposure – mostly to active managers or active ‘bets’ that you think will add value.

LaMonica: Now, the industry provides ready-made cores that help investors with lower balances that don’t diversify as easily. These are multi-asset funds and ETFs. The name on the box really explains what’s inside – they are collective investment vehicles that contain multiple asset classes.

Jayamanne: And multi-asset funds have different objectives to normal funds. We can see this through benchmarks for many of them. One of the most common is real return. Real return funds look to achieve a percentage return above CPI. Then, there are multi-asset income funds that focus on generating income from different asset classes for investors. There’s also multi-asset funds that focus purely on capital growth.

LaMonica: Although this does not translate to the same amount of relevancy as a custom portfolio that you have created based around your goals, it is one step closer than just chasing a benchmark return.

Jayamanne: There are exceptions to the rule.

Morningstar’s managed fund and ETF coverage includes the Vanguard Diversified ETF range, consisting of 4 ETFs with differing risk profiles. The Balanced, Growth and High Growth are awarded a silver medallist rating, and the Conservative a Bronze. This is one of the exceptions. These funds allocate a set percentage to an underlying set of passive funds.

LaMonica: One trade into the Vanguard Diversified High Growth ETF (ASX: VDHG) gives exposure across asset classes, sectors and styles.

It gives 36.5% exposure to Vanguard Australian shares, 26% to Vanguard International shares, 16% to the hedged version, 7% to the Vanguard global aggregate bond index, 6.4% to the Vanguard smaller companies index, 4.9% to Vanguard’s emerging markets index, and 3% to Vanguard’s fixed interest index.

Jayamanne: The management fee is 0.27%, and if investors wanted to invest across all of these funds, they can do so with one trade.

We mentioned that they were a silver medallist. The reason that our analysts like VDHG is that they believe it is an efficient way to access a well-diversified portfolio of securities across different asset classes, regions and sectors.

LaMonica: That sounds like exactly what multi-asset funds are supposed to do.

Jayamanne: Exactly, Mark. There isn’t much to say about the strategy, as it is just an allocation to underlying passive funds. The goal of the fund is to beat the weighted average benchmark of all the underlying passive funds.

LaMonica: If we look at managed funds, the pool of multi-asset offerings widens. The disclaimer with managed funds is that they usually require a larger initial investment, but additional contributions do not attract fees or brokerage in most cases.

Jayamanne: Perpetual’s Diversified Real Return earns a Silver medallist rating from our Manager Research team. The fund is heavily weighted towards cash as at 14 March 2023. The fund’s mandate allows the manager to allocate anywhere between 0-100% in each asset class, allowing them to decide where opportunities lie, and does not force them to allocate to asset classes where they do not see attractive opportunities. It is a classic example of a real return fund – meaning that they are aiming to achieve a percentage above inflation, to maintain the value of the capital and then grow it. In the case of Perpetuals Diversified Real Return fund, it aims to deliver CPI + 5%.

LaMonica: It should be noted that this is a very different approach than the Vanguard product. Real return strategies are designed to lower volatility.Because it is actively managed, our analysts have more to say about the strategy and the goals of the fund.

Jayamanne: They say ‘The benefits of a twofold return-seeking and risk-management approach make Perpetual Diversified Real Return a fine choice within the flexible cohort.’ Let’s go into this a little more.

LaMonica: Our analyst, Michael Malseed, mentions that they use a few implementation methods to skew the risk and reward of the fund, one of them being hedging. Capital preservation and protection is really important in the fund, and they adjust between the varying exposures in their asset classes to ensure that this is at the centre of the strategy. He says this has led to exceptional downside protection, but also mentions that the managers aren’t afraid to take risk to generate strong absolute returns when appropriate. He mentions that this is shown in the risk adjusted returns relative to the category benchmark.

Jayamanne: So the caveat to this, and we’ve mentioned this a few times, is that managed funds do typically require a high initial investment. The silver medallist rating is attached to the fund’s Z class, which is a $25,000 minimum investment, with a management fee of 0.35%, and 10% of the outperformance, capped at 1% p.a.

LaMonica: For investors with smaller balances, they have the fund available through Perpetual’s Wealthfocus Investment Advantage platform – the minimum initial investment is $2,000. It’s important to note that because of the fee difference, the silver medallist rating does not apply. The fee is extremely different – almost 1% more at 1.1%, with estimated indirect costs and fees pushing it up to 1.24%.

Jayamanne: And we’ve spoken before about how large fees can have a huge impact on your return outcome. If we look at a quick example - $100,000 with $1,000 additional investment per month over 20 years, with a 5% return.

LaMonica: Class Z would be at $637,311, paying almost $34,000 in fees. If it were in the wealthfocus platform version, the investment would be valued at $559,899 after 20 years, paying over $111,000 in fees.

Jayamanne: That’s a significant difference, and shows why we need to be wary of fees when investing in managed funds and ETFs. And we need to be honest about the fee.

If we look at multi-sector investments in general – there are a few downsides to these sorts of portfolios.

LaMonica: One downside of these “set and forget” portfolios is that it makes it a bit harder if you need to switch your asset allocation as the need arises. Rather than simply putting new contributions into under-represented asset classes to alter this allocation, you only have one option. This option is to switch the whole asset allocation into a different risk profile.

Jayamanne: This results in a taxable event, which can impact your investment returns.

LaMonica: There is no free lunch. Everything that’s worth doing in life requires effort, and although there are some simplified solutions that investors can look at for their portfolios, they still need work – monitoring and maintaining portfolios across long time horizons, and ensuring they are still fit for purpose. For example, investing in a 90% equity portfolio at year 1 of a 25-year time horizon will not be the right investments at year 24. These portfolios offer an alternative to apps or platforms with multiple fees attached and can help investors by offering a core portfolio.

Jayamanne: Multi-asset vehicles are a great way to take a large piece of work off your plate, or a jumping off point for new investors. Regardless of these diversified options, it’s important to understand that they do not cater for your situation over the long-term, and do not take your goals into account. Your goal might be income, or it might be low volatility. It might be capital growth. Managers do not take this into account. Custom portfolios that you monitor and maintain will.

LaMonica: The good thing about investing is that there are a multitude or products, platforms, strategies and avenues to find an approach that is right for you. Simplifying your portfolio to one ETF might not be the right strategy for you due to the inflexibility of the asset allocations, and no true match to your individual risk capacity. The right balance between simplicity and customisation may evolve over time depending on your interest in investing, and the needs of your portfolio. Ultimately, the goal is to invest. Multi-asset investments can provide solid, pre-diversified building blocks for investors that have no interest in picking individual shares.