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Is their low cost, diversified nature too good to be true?
Thursday 03 Aug 2017 Author: Emily Perryman

Investors have been pouring money into the Vanguard LifeStrategy funds, attracted by their low fees, diversification and strong track record. But the funds’ inability to respond to market movements has led some people to question whether their advantages are overstated.

WHAT ARE THE VANGUARD LIFESTRATEGY FUNDS?

The funds provide investors with a static portfolio made up of Vanguard’s equity and bond index funds. You can choose from one of five funds, ranging from a 20% equity exposure all the way up to a 100% equity exposure, with any remainder in bonds.

The funds are passive, which means they track indices rather than employing a fund manager to make strategic investment decisions. This enables them to have a low ongoing charge of 0.22%.

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The funds are built on a market capitalisation-weighted basis – the largest companies in the indices carry a higher weighting than the smallest companies.

The US is home to the greatest number of large cap stocks, but to make the funds more appealing to UK investors Vanguard has given them a UK bias. For example, the Vanguard LifeStrategy 60% Equity Fund (GB00B3TYHH9) has a 25% equity weighting to the UK, considerably higher than the UK’s weight in the global market.

James Norton, senior investment planner at Vanguard, says one of the advantages of the funds is their diversification. Someone who invests in the 60% equity fund will get exposure to 17 underlying funds containing a total of 19,822 equity and fixed income holdings.

The funds rebalance to ensure the equity and bond allocations remain consistent over time.

WHO ARE THEY SUITABLE FOR?

The funds are designed to be a one-stop-shop solution that meets the needs of investors regardless of their risk profile. The funds with the lowest equity exposure are designed for low-risk investors and the funds with the highest equity exposure are for higher-risk investors.

Mark Entwistle, an investment manager at Walker Crips, says the products may be particularly appealing for smaller investors, for whom high costs can make building a diversified portfolio uneconomical.

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‘Vanguard’s ready-made, diversified proposition may suit such investors who are looking for a simple, diversified approach to their investments without needing to involve a finance professional,’ he explains.

Dan Smith, investment analyst at Thomas Miller Investment, says passive portfolios are suited to investors who are starting to accumulate wealth and investing regularly into the markets. He says this typically this implies a long investment time horizon.

What are the disadvantages?

Although the LifeStrategy funds are diversified across equities and bonds, they exclude other asset classes such as infrastructure, absolute return, property and commodities.

Entwistle says in order to achieve a truly diversified portfolio, investors would ideally hold a portfolio exposed to these other asset classes alongside a LifeStrategy fund. ‘This would be clunky, however, and would mean more work for the investor,’ he adds.

The funds have a bias towards large-cap stocks. Smith reckons investors would benefit from a higher allocation to the mid-cap sector as it tends to include companies at earlier stages of development with stronger growth characteristics.

‘History also suggests that over time mid-cap stocks have outperformed large-cap in virtually all developed equity markets, albeit with slightly higher levels of volatility,’ he says.

THE PASSIVE VS ACTIVE DEBATE

Unlike active funds, the LifeStrategy funds can’t outperform their benchmark index.

The vast majority of active US equity managers have failed to outperform the S&P 500 in recent years, but there are UK and Asia equity managers who have consistently outperformed their benchmarks.

For example, since the Vanguard LifeStrategy funds launched in 2011 the Threadneedle UK Equity Income Fund (GB00B888FR33) has outperformed the FTSE All Share by almost 40%.

Randal Goldsmith, an analyst at Morningstar, says it’s very difficult to identify at the outset which managers will outperform.

‘If you’re going with an active manager you need to look at their performance for a long time before you can be confident in their abilities. Even then, you don’t know what is going on in the manager’s life or what their priorities are, so what they do going forward could be very different to what they’ve done in the past,’ he argues.

The LifeStrategy funds have performed strongly since their inception, but Smith says this is partly owing to the fact that equities and government bonds have been the principle beneficiaries of central banks’ monetary stimulus programmes.

Smith says equities and bonds currently look expensive both relative to history and on an absolute basis.

‘Going forward, we expect some reduction in central bank stimulus and it seems logical to expect those markets that have benefitted most from central bank policies to suffer some losses when stimulus is withdrawn. This is not a position or opinion that can be expressed using the Vanguard strategies, which to our mind is a negative factor, recognising that not taking such positions is precisely what the strategy is designed to do,’ adds Smith. (EP)


 

Alternative Options

BlackRock’s Consensus range consists of five funds ranging from a 35% equity exposure to a 100% equity exposure. The equity allocation isn’t fixed but instead can move within a defined range. The BlackRock Consensus 85 Fund (GB00B8D0SR58) can invest between 40% and 85% in equities.

Legal & General has eight multi-index funds but they can invest opportunistically, as long as this is within the fund’s targeted risk level. As well as bond and equity index funds, they can hold UK commercial property.

Another alternative would be to create your own portfolio of index funds. It could be more diversified and better suit your needs, but it’s likely to be more expensive.

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