The most fundamental task in constructing the foundations of a portfolio is really to align the risk and return expectations of that portfolio with the risk and return expectations of the investor. A tried-and-true method of doing this is through what we call asset allocation. This means how much of the portfolio is going to be invested in higher-risk assets such as equities, which can also have a higher return potential, and how much will be invested in lower-risk assets such as fixed income, which have a lower return potential. This overall mix is actually the starting point for aligning the risk of the portfolio with the risk tolerance of the investor.

Mixing stocks and bonds together in a portfolio in this way has really important diversification benefits and it lowers the overall risk of the portfolio. This is because stocks and bonds have low correlation to each other, which means that they tend to react differently to the same real world event. It’s also really important to diversify within both the equity and bond portions of the portfolio. Any one stock is typically going to be more volatile than the market as a whole, so a diversified foundation is important. It reduces the risk from the impact of any one security. This is where ETFs can be really powerful. They’re diversified and precise building blocks, and they enable the investor to really control what the portfolio contains. For example, using ETFs, you can control the mix of Canadian, U.S. and international exposures in the equity part of your portfolio. You can also control the mix of government bonds versus corporate bonds in the fixed income part of the portfolio. The great advantage of using ETFs for this foundation is that they’re very, very low-cost. They harness overall market returns which are available to everyone with a minimal drag from fees that tend to eat into your return.

Asset allocation ETFs are a more recent and very important innovation in Canada. The basic idea is that while it’s important to match the risk of the portfolio to the risk of the investor, most investors will actually fit well within four or five predefined risk profiles. So rather than having to build a completely custom foundation for every investor, you can generally start with a template. Asset allocation ETFs can provide that template. Each invest according to a predefined mix of equities and fixed income. For example, a balanced asset allocation ETF might hold 60% stocks and 40% bonds. It’s then also diversified within both the equity and the fixed income components. Now, very importantly, these products are rebalanced on a regular basis to ensure that they stay in line with their target asset allocation. So, as long as the investor’s risk profile does not change, the asset allocation ETF will remain a suitable foundation. For example, a more conservative investor with a low risk tolerance might invest in a conservative asset allocation ETF, which invests 80% of its portfolio in fixed income and only 20% in equities. On the other hand, a more growth-oriented investor with higher risk tolerance, higher return expectations, and a longer time horizon might invest in a growth asset allocation ETF, which invests only 20% of its portfolio in fixed income and 80% in equities.

So the combination of the convenience and low cost of these all-in-one asset allocation ETFs has really, really resonated with lots and lots of different audiences. And we have seen both investors and advisors really embrace these solutions and find new uses for them. And so we’ve seen an increasing number of advisors really embrace these solutions as ways to create efficiencies in their business or in their practice while also fortifying or reinforcing their client portfolios. The advisor, in using these solutions, is able to save time that can be used on relationship management, business development, adding unique complementary entry ideas to portfolios while outsourcing the creation of these portfolio foundations. By the same token, each asset allocation ETF delivers exposure to over 15,000 individual securities in a tightly-controlled asset allocation framework and an MER of around 20 basis points. So nothing is compromised in terms of quality or client fit. It ends up being a win-win for both the client and the advisor.