Rates are low but the spectre of inflation sits somewhere on the horizon. How do we construct portfolios in this environment to diversify risk without destroying returns? This article has a look at some ETF funds that might be interesting as alternatives to traditional Fixed Income in portfolios. We are looking for low beta or low volatility outside the govt. bond space.
What we would like to find is a group of ETF's that provide reasonable returns at low volatility and low correlation to Australian or Global Share funds.
Using 3 filters, funds must have:
A 5 year return of greater than 5%
A volatility of less than 10%
I am excluding "Portfolio funds" such as Vanguard Balanced Portfolio or similar.
Out of 223 ETF's I get 4 hits. 2 absolute return funds and 2 corporate bond funds.
Looking for a little bit more return? If I alter the filters to the following;
1 Year total return of greater than 7%
Volatility of less than 11% (the ASX200 is about 13%)
Continue to exclude portfolio funds.
This time I get 5; two risk managed funds, an emerging markets debt fund, a dividend income fund and an absolute return fund.
The major issuers of ETF's all produce model portfolios. A quick look at those portfolios shows us that a typical Growth Portfolio has an expected volatility of about 12.5%. With about 25% of assets held in fixed interest.
If we eliminate the traditional fixed interest component (leaving corporates or EM bonds) but constrain the risk or volatility to below 12.5% using the low beta funds above we may be able to increase our return per unit of risk.
So here is an example portfolio;
This portfolio has a return comparable to most of the growth portfolios out there but with a lower expected volatility. Defensive assets I have (re) defined as those having a volatility of less than 8%.
The problem with this portfolio is that the correlation with equity assets will be higher than a growth portfolio with traditional fixed interest assets. The overall risk is lower but the correlation to equities higher.
Two funds stand out in this analysis and I think may be useful in portfolio construction. they are XARO and CRED. Both bond funds but with a difference. They both have a history of good returns, low volatility and low correlation to equity assets.
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Nothing in this email should be taken as a recommendation. We have not considered or taken into account any of your personal circumstances. Always coonsider your own circumstances and read the PDS (available on Accument) before investing.