Best-in-Class ETFs for Ultimate Buy & Hold Portfolio
What’s the best set of ETFs to use if I want to implement Paul Merriman’s Ultimate Buy and Hold Portfolio as a DIY investor? That’s the question I set out to answer working with Paul in preparation for the launch of his portfolios at Motif Investing, but the same answer may be useful to DIY investors regardless of where and how they want to invest.
To start, we need to define what we mean by “best.” Obviously, keeping expenses low is a priority, but the Ultimate Buy and Hold Portfolio is based on academic research that says there’s been a higher return in small (low average market capitalization) and value (low price-to-book) equities. That higher return has come with higher volatility. But by combining several different asset classes that are at least somewhat uncorrelated – or better yet, negatively correlated – a higher return per unit of risk is possible. So, what we’re looking for are representative ETFs for each asset class that tilt towards small and value while keeping expenses as low as possible.
Other attributes matter as well. Overall we used seven characteristics in determining which ETFs to use: expense ratio, average market cap, price-to-book, number of stocks, bid-ask spread, turnover, impact on overall portfolio expected returns and yield as reported by Morningstar X-Ray.
You can see the results in the table below, and the recommended Best-In-Class ETF portfolios at www.paulmerriman.com/etf.
As you can see, the best-in-class ETFs, though about 1/10th of 1% higher in expenses than the cost leader Vanguard, provide a significantly lower price-to-book, lower average market cap and much broader asset class coverage. I’ve also included the All-Value and All-Small-Cap-Value Best-in-Class recommendations, which tilt even more toward small and value. To see why these might be of interest, I encourage you to look at the 2017 fine tuning tables which cover worldwide balanced and all-value allocations. For most investors, the right answer will be a mix of fixed income and equities, and the tuning tables provide a good context for making that choice.
Does this mean the Best-in-Class will always outperform the others?
Does this mean it’s time to abandon DFA in favor of DIY?
I think the answer to both questions is “no,” and here’s why.
First, as Paul is fond of saying, “you can’t buy the past.” History is the best teacher we have, but historical patterns can disappear for long periods of time, then reappear suddenly or not at all. The Best-in-Class ETFs will likely not be the best performing in the short term. And if the academic observations that have held for the past few decades hold into the future, there’s a good chance it will be among the best performers in the long-haul.
The timeframe for the backtest is limited by the newest funds, so it’s hard to judge anything about likely long-term return rates. However, we can see thoughout is higher volatility in the all-value portfolio — something that historically goes along with it’s higher returns.
Regarding DFA, asset-class returns are a small part of choosing to work with an advisor. The primary consideration should be whether you’ll do better working with an advisor or not. This has more to do with your personal experience, knowledge, temperament, and interest in managing your investments than it does with the DFA funds specifically. The DFA funds are still superior in many ways, but both the DIY and DFA-Advisor paths can lead to success. Which is best depends mostly on you. I believe the best-in-class recommended portfolios are sound and diverse. I also know they’ll evolve over time, and welcome your input to help us improve them.