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Finding the Right Balance: How Higher Equity Allocations in Balanced ETFs Could Generate Better Returns

With more than 800 exchange traded-funds (“ETFs”) listed in Canada, it has become increasingly difficult for investors to know which ETFs to buy and to build into their portfolio. ETF providers have addressed this challenge by offering so-called “Balanced” or “All-in-One” funds: ETFs that buy other ETFs as part of an asset allocation strategy. With one ETF purchase, Canadian ETF investors can get a full asset allocation geared towards their risk/return objectives.

These ETFs have become a popular, easy-to-use tool for investors seeking instant diversification at a comparably low effort and cost to traditional portfolio management methods. With discount brokerage trad- ing volumes growing faster than ever, these ETFs have become the darling of personal finance columnists and DIY investors alike as a great investment democ- ratizer — with an ETF option that’s potentially suitable for everyone. According to National Bank, the multi- asset ETF category has gathered nearly $7 billion in assets under management as at June 30, 2020, the majority of which have come from self-directed investors.

Balanced ETFs have been launched by Canada’s leading ETF providers, including Vanguard, iShares, BMO, and us: Horizons ETFs. While Vanguard has certainly had the first-mover advantage in launching and gathering assets in these funds, if you look at the performance numbers, that’s really the only advantage they have
at this point.

Since the inception of the Horizons Conservative TRI ETF Portfolio (“HCON”) and the Horizons Balanced TRI ETF Portfolio (“HBAL”), they have outperformed the comparable Vanguard offerings. On a total return basis (after fees), HCON delivered 206 basis points (“bps”) of outperformance relative to the Vanguard Conservative ETF Portfolio (“VCNS”) for the two year period since its inception on August 1, 2018, and HBAL delivered 206 bps of outperformance relative to VBAL for that same period.




Reasons for Outperformance

Higher Equity Allocations

One of the key differentiators with our Balanced ETFs is that, upon launch, we made a strategic decision
to increase the equity allocation of their strategies based on the long term Sharpe ratio (risk/return profile) of owning equities versus bonds over the last two decades. To date, HBAL’s higher 70/30 equity allocation vs. VBAL’s traditional 60/40 allocation has resulted in a significantly better return trajectory. Similarly, HCON’s 50/50 allocation is contrasted by the traditional 40/60 allocation used by VCNS, which is overweight on fixed income exposure.

It’s important to underscore that the respective 70/30 and 50/50 allocations were not chosen to simply capture upsize movement in the equity market; rath- er, it’s our firm’s belief that a 60/40 split in a balanced portfolio or a conservative 40/60 allocation places too much emphasis on fixed income in a world where the nature of capital markets has changed dramati- cally, with interest rates on a multi-decade downward trajectory while investor longevity is increasing.

Here are three reasons why we chose higher equity allocations over the traditional allocations used by Vanguard and others, for our ETFs:

1. Reduced Longevity Risk: The trend of younger investors using balanced ETF portfolios has increased over the last few years, DIY-investors seeking a simple way to begin saving for retirement. These investors generally have a longer investment time horizon compared to older investors. In this scenario, equities have less longevity risk for a few reasons:

  1. Increased life expectancies require greater portfolio growth
  2. Historically stronger long-term performance
  3. Potentially small yearly withdrawal limit risk

2. Declining Interest Rates and Low Yields: With interest rates at all-time lows and negative in many countries, fixed income isn’t providing the same advantages for portfolios as it used to. On June 30, 2000, 10-year U.S. Government bonds were yielding 6.03% compared to 0.65% 20 years later.
Source: Bloomberg, as at June 30, 2020.

3. Historically Strong Equity Performance: The last decade has been favourable for equities, with the S&P/TSX Capped Composite Index returning 6.35% annualized on a total return basis for the 10-year period ending June 30, 2020. Perfor- mance for U.S. equities has been particularly favourable over the last 10 years as well; with the S&P 500 delivering a 13.99% annualized total return and the NASDAQ-100 delivering a 20.69% annualized total return for the same period.

NASDAQ Exposure

Another reason why HBAL and HCON have outper- formed their Vanguard counterparts, to date, is due to their greater NASDAQ exposure.

Since 2008, the NASDAQ-100 has outperformed theS&P 500 in 10 of the 12 measured years. The NASDAQ, which is more heavily weighted towards technology, consumer services and health care companies,
has also recently seen strong performance with the increasing importance and relevance of these sectors, particularly during the disruptive market landscape due to the COVID-19 pandemic.

Meanwhile, we have chosen to allocate less domestically to Canada. The average Canadian investor has
a significant bias towards domestic stocks of ap- proximately 60%, despite Canada only accounting for approximately 3% of the global stock market as represented by the MSCI World Index which was actually highlighted by Vanguard in a 2017 study.

For the one-year period ending June 30, 2020, HBAL’s overweight to U.S. Equities —specifically, its relatively large NASDAQ position — was a significant driver of outperformance. The TSX/S&P Capped Composite delivered a total return of -2.17% for the one-year period ending June 30, 2020 and underperformed both the S&P 500 and NASDAQ-100, which returned 7.51% and 33.78% respectively on a total return basis for the same period.

Horizons ETFs also had more freedom to make this asset allocation decision since the underlying ETFs held by HBAL and HCON are part of our Corporate Class Total Return Index suite of ETFs ‡(“TRI ETFs”), which are not anticipated to pay dividends. Some home bias for Canadian investors can be understood when you factor in the tax-efficiency of Canadian eligible dividends, but this consideration is irrelevant if foreign dividend taxation is not a concern. Instead, using global asset allocation with TRI ETFs, investors can take a position in line with a non-Canadian bias without worrying about higher taxation on foreign dividends from U.S. and international stocks.

Strategic Asset Allocation: Ideas in Practice

The following analysis is for illustrative purposes only and seeks to show the historical differences in performance between two hypothetical portfolios. The portfolios are priced according to the following assumptions:

1. They are priced in Canadian dollars
2. They use a strategic asset allocation that is rebalanced on a semi-annual basis
3. Upon rebalance, the hypothetical portfolio would be automatically re-weighted to its fixed asset allocation
4. This is a total return analysis that assumes all reinvestment of distributions
5. This report is based on index total return levels, not price, and does not include trading commission or other expenses associated with a rebalance
6. Neither the portfolios nor any of the indices are directly investable
7. There is no application of foreign withholding tax on the dividends, which is a consideration that could increase the tax liability of a Foreign Equity portfolio depending on the type of taxable account it is held in

Both portfolios use the FTSE Canada Universe Bond Index for their fixed income exposure and both portfolios allocate equity exposure equally between the U.S. and Canada. The second portfolio equally weights the S&P 500 and NASDAQ-100.

The results of the back-test, while historical in nature and completely hypothetical, potentially validate the idea of overweighting the equity portion of a portfolio in practice. An initial outlay of $10,000 made into each strategy on June 30, 2005 would have resulted in an additional $5,860 at the end of the 15-year period and 138 bps of annualized outperformance over the entire holding period for the 70/30 strategy.


Potential Tax Considerations

HCON and HBAL have the added benefit of hold- ing Horizons ETFs family of corporate class TRI ETFs, which are not anticipated to pay out taxable distributions. While HBAL and HCON have paid out taxable distributions from their use of currency forwards and could potentially pay out capital gains distributions from rebalancing the portfolios, none of the typical distributions paid by the underlying index exposures are expected to flow through to end unitholders. More information about our suite of Total Return Index ETFs can be accessed here:


For investors seeking long-term capital growth, the potential effectiveness of Horizons TRI ETF portfolios has been demonstrated.

From HBAL’s70/30 allocation, to both HBAL and HCON’s exposures focused on the world’s largest markets, our historical outperformance versus Vanguard’s VBAL and VCNS has been based on a strategy built for today’s investment landscape.

Finally, with the potential tax-benefits of HBAL and HCON holding our Corporate Class Total Return Index ETFs, the advantages of owning them in taxable accounts might be even greater for Canadian investors.

Learn more about HBAL and HCON:

The ETFs

HCON seeks moderate long-term capital growth using a conservative portfolio of exchange traded funds. HCON invests primarily in Horizons’ Total Re- turn Index ETFs. The portfolio targets a long-term asset allocation of approximately 50% equity secu- rities and 50% fixed income securities at the time of any rebalance. The portfolio will be rebalanced semi-annually in order to seek a consistent level of conservative risk. HCON will use currency forwards to hedge its non-Canadian dollar currency exposure to the Canadian dollar at all times.

HCON is subject to the fees of its underlying ETFs. Horizons ETFs currently anticipates that the manage- ment expense ratio of HCON will be approximately 0.15%, and will not exceed 0.17%, while the aggre- gate trading expense ratio of the portfolio of Hori- zons TRI ETFs held by HCON will be approximately 0.20%. As trading expense ratios include expenses outside of the Manager’s control, the trading ex- pense ratio of HCON is subject to change at any time.

HBAL seeks long-term capital growth using a bal- anced portfolio of exchange traded funds. HBAL primarily invests in Horizons’ Total Return Index ETFs. The portfolio targets a long-term asset allocation of approximately 70% equity securities and 30% fixed income securities, and rebalances semi-annually to ensure the composition of HBAL reflects a consis- tent level of balanced risk. HBAL will use currency forwards to hedge its non-Canadian dollar currency exposure to the Canadian dollar at all times.

HBAL is subject to the fees of its underlying ETFs. Horizons ETFs currently anticipates that the management expense ratio of HBAL will be approximately 0.16%, and will not exceed 0.18%, while the aggregate trading expense ratio of the portfolio of Horizons TRI ETFs held by HBAL will be approximately 0.23%. As trading expense ratios include expenses outside of the Manager’s control, the trading expense ratio of HBAL is subject to change at any time.

VCNS – Vanguard Conservative ETF Portfolio seeks to provide a combination of income and moderate long- term capital growth by investing in equity and fixed income securities.

VBAL – Vanguard Balanced ETF Portfolio seeks to provide long-term capital growth with a moderate level of income by investing in equity and fixed income securities.

Commissions, management fees and expenses all may be associated with an investment in Horizons Balanced TRI ETF Portfolio or the Horizons Conservative TRI ETF Portfolio. (the “ETFs”) managed by Horizons ETFs Management (Canada) Inc. The ETFs are not guaranteed, their values change frequently and past performance may not be repeated. The prospectus contains important detailed information about the ETFs. Please read the prospectus before investing.
‡Horizons Total Return Index ETFs (“Horizons TRI ETFs”) are generally index-tracking ETFs that use an innovative investment structure known as a Total Return Swap to deliver index returns in a low-cost and tax-efficient manner. Unlike a physical replication ETF that typically purchases the securities found in the relevant index in the same proportions as the index, most Horizons TRI ETFs use a synthetic structure that never buys the securities of an index directly. Instead, the ETF receives the total return of the index through entering into a Total Return Swap agreement with one or more counterparties, typically large financial institutions, which will provide the ETF with the total return of the index in exchange for the interest earned on the cash held by the ETF. Any distributions which are paid by the index constituents are reflected automatically in the net asset value (NAV) of the ETF. As a result, the Horizons TRI ETF receives the total return of the index (before fees), which is reflected in the ETF’s share price, and investors are not expected to receive any taxable distributions. Certain Horizons TRI ETFs (Horizons Nasdaq-100 ® Index ETF and Horizons US Large Cap Index ETF) use physical replication instead of a total return swap. The Horizons Cash Maximizer ETF and Horizons USD Cash Maximizer ETF use cash accounts and do not track an index but rather a compounding rate of interest paid on the cash deposits that can change over time.
The information contained herein reflects general tax rules only and does not constitute, and should not be construed as, tax advice. Investors situations may differ from those illustrated. Investors should consult with their tax advisors before making any investment decisions.
Certain statements may constitute a forward-looking statement, including those identified by the expression“expect”and similar expressions (including grammatical variations thereof). The forward-looking statements are not historical facts but reflect the author’s current expectations regarding future results or events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These and other factors should be considered carefully and readers should not place undue reliance on such forward looking statements. These forward-looking statements are made as of the date hereof and the authors do not undertake to update any forward-looking statement that is contained herein, whether as a result of new information, future events or otherwise, unless required by applicable law.
The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.
“Standard & Poor’s®”and “S&P®”are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”) and “TSX®”is a registered trademark of the TSX Inc. (“TSX”). These marks have been licensed for use by Horizons ETFs Management (Canada) Inc. The ETF is not sponsored, endorsed, sold, or promoted by the S&P, TSX or their affiliated companies and none of these parties make any representation, warranty or condition regarding the advisability of buying, selling or holding units/shares of the ETF.
Nasdaq®,Nasdaq-100®,and Nasdaq-100 Index®, are trademarks of The NASDAQ OMX Group, Inc. (which with its affiliates is referred to as the “Corporations”) and are licensed for use by Horizons ETFs and Horizons ETFs Management (Canada) Inc. The Fund(s) have not been passed on by the Corporations as to their legality or suitability. The Fund(s) are not issued, endorsed, sold, or promoted by the Corporations. THE CORPORATIONS MAKE NO WARRANTIES AND BEAR NO LIABILITY WITH RESPECT TO THE FUND(S).

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