This post is inspired by Optimized Portfolio’s totally on-point version of the “distracted boyfriend” meme. AVGE, Avantis’s All Equity Markets ETF, has gotten a lot of buzz lately - does it deserve a strong wandering eye from the Risk Parity investor as well?
The release of AVGE, the All Equity Markets ETF from Avantis, in late September, 2022 has brought a worthy competitor to VT, Vanguard’s Total World Stock ETF. Combining all-in-one convenience with a factor tilt towards equities with higher expected return, AVGE looks poised to attract lots of investing dollars in the months and years ahead, some of which will come from investors who switch over from the market cap-weighted VT. Although its expense ratio of .23% is higher than VT’s basement rate of .07%, AVGE’s is still low enough to check the boxes as a low-cost index fund to help cover the equity markets all in one fell swoop.
Although new ETFs are released all the time, AVGE seems to have a particularly big splash, garnering attention from a variety of investment bloggers, YouTubers, and educators, notably Nomadic Samuel over at Picture Perfect Portfolios, Rob Berger, and Slow Brew Finance. John at Optimized Portfolio is another who has taken a close look at AVGE, which you can find here:
I second his analysis, and note AVGE’s pros and cons for the general investors. But what about AVGE from a Risk Parity perspective - how might AVGE play a role in a Risk Parity portfolio?
If you’re interested in following up with the fund itself, here is info page from Avantis:
As usual with my looks at assets, I begin with laying out the evaluation criteria: what are we looking for?
- Correlation: The oft-cited “holy grail” for Risk Parity investors is finding multiple sources of return that have low, or hopefully negative, correlation with each other. Diversifying the portfolio this way helps create stable portfolios with higher risk-adjusted return numbers (that can be leveraged up, if you so desire). I’ll be looking to see how correlated AVGE is to other asset classes beside equities, especially in comparison to VT.
- Performance: Of course, no matter how diversified, if those sources don’t have a positive expected return, then they won’t do the investor much good. To check on return, the Risk Parity relies on backtests with as long a timeframe as possible to make a judgment. In the backtests, I’ll be comparing AVGE to VT and to a simple three-fund equity portfolio made up of three of the funds within AVGE: AVUS, AVDE, and AVUV.
- Composition: In this case, I’ll be looking at how AVGE is constructed. It’s a “fund of funds,” with ten other Avantis funds combined (at different weights) to create the All Equity Market fund.
The relative youth of AVGE is certainly a problem here. With just three full months of data, I wouldn’t put anything more than a feather’s worth of weight on these numbers. But, it’s all we have, so here you go:
Understanding AVGE is pretty straight-forward - it is a lot like VT with correlations of .98 to each other. Compared to alternative asset classes, though, AVGE and VT present a slightly different profile. AVGE is more highly correlated to commodities than VT is, but VT is more highly correlated to bonds, gold and managed futures than AVGE. Being less correlated to more alternatives counts as a small win for AVGE, at least over the past three months.
At the same time, it looks like you’d get more of a diversification benefit just by using my sample three-fund equity portfolio: AVUS, AVDE, and AVUV. If you compare AVGE to the four alternatives, then those three funds to the four alternatives, you find a mixed set of results, but generally, lower correlations when using the three funds.
Again, the youth of AVGE really limits the significance of the backtest, though in this case, there is a work-around that gives us another eight months of data. I deconstructed AVGE into the ten constituent funds according to the initial weights (they’ve since moved slightly; you can track the current percentages here).
The second portfolio is the ol’ standby, VT, and then the third portfolio in the backtest is a version of the equity strategy I use in the RPC Stability portfolio (which has 10% each in large-cap growth, small-cap value, and international). I’ve amended it a bit to use Avantis funds only to try to keep an apple-to-apples comparison and highlight the portfolio allocations, not the selection of specific assets. So, I use one-third in AVUS, the Avantis US Equity ETF, one-third in AVDE, the Avantis International Equity ETF, and one-third in AVUV, the US small-cap value ETF, also by Avantis.
* Note: If doing this for real, I’d use IWY instead of AVUS, and then DFAX, not AVDE, though the two Avantis funds here are fine. I love AVUV as a small-cap value fund, so I’d keep that. I’d also have it be 30% each in IWY and AVUV, and 40% in DFAX, to show a little less home country bias. Breaking down into third does have advantages for easier rebalancing, though, as I explain below.
I tested the three portfolios using quarterly rebalancing, given the short timeframe. Here are the results since February 2022, a horrible year for equities.
Well, that’s no fun. I guess my improvised three-fund equity portfolio was the least bad, but it was even more volatile. It beat out the deconstructed AVGE by 1.5% which is nice. VT was the worst of the three, and significantly so. To reiterate, this isn’t much of a backtest, though, so don’t make too much of it.
Just some thoughts:
- I’m not a fan of REITs, so it’d be fine with me if AVGE skipped even the small 3% allocation to AVRE and put it in something else instead. As I covered in my exhaustive (exhausting?) series last summer, I don’t see much reason to overweight REITs in a portfolio, since they don’t really do what investors expect that they do (diversify your portfolio, capture the housing market, etc). In this case, it may make some sense, as REITs are excluded from the other Avantis funds that make up the portfolio, so the exposure to REITs is really just to bring it closer to market cap weights. I can see the rationale, but I’d still skip the REITs.
- There is a US bias in the holdings, 72/28, which is a bit more than I would like. I generally target 60% US and 40% non-US (don’t quote me, but I think the true breakdown is 58/42), so AVGE is more tilted than I would do myself.
- I’m just not sure if you really need US small-caps (AVSC) and US small-cap value (AVUV) at the same time, or else Emerging Markets (AVEM) and Emerging Markets Value (AVES) at the same time. This seems like needless complexity Since there is certainly overlap in the holdings in each pair, and higher return expected in the value version, why not just have those?
- Avantis is a great shop, and, in general, I totally trust their judgment that their allocation among the ten constituent funds is based on solid research. But I also wonder, is this ready-made mix necessarily the best for each investor? If one is already holding a large position in AVUV, for example, then adding AVGE with its allocation to AVUV within it complicates matters. I guess if you really do want just one fund, then Avantis' recipe is going to be better than most, but otherwise, the ten-fund puzzle seems a bit much.
Deserted Island Funds
Another question I have is whether going for an all-in-one fund really makes sense anyway. It is said that a fund like this is convenient and easy, and suitable for beginner investors. They have everything you need in the equity space, we are told, and with one purchase of AVGE or VT, you gain exposure to a broad variety of equities (notice I didn’t say diversification!). Funds like AVGE or VT are often talked about as if each were a good “Deserted Island” fund - the one thing to invest in before you pull a Chuck Noland.
Honestly, I have always found all that a stretch. I understand the mental exercise of deciding what might be the one best fund, but I can’t figure out why people actually go and do that. The deserted island trope is a hypothetical, but… you’re not currently a deserted island, there is an infinitesimally small chance you will ever be, and if you ever are, you have bigger problems than your investments.
Is a one-stop equity fund easier? Not really. What would make investing time consuming for me would be having assets in different places - at Vanguard, Schwab, Interactive Brokers, and then your old 401k from 2003 at TIAA-CREF etc. From a management perspective, all else being equal, I’d rather have 100 funds at Vanguard, than one at Vanguard and one at Fidelity. Your tax statements are pooled, and they appear on the website in list form, so I’ve never seen what was the big deal with having ten different ETFs in your brokerage as opposed to two.
All in all, there is no reason to artificially confine yourself to X number of funds, as these thought exercises would have you do. Meanwhile, the benefits of having multiple funds that offer diversification within the equity space are important. Multiple funds allow you to rebalance between them, which can result in an extra boost to your portfolio. This isn’t the right time for a full explanation of that, but take a look at my review here of Michael Kitces’s piece on rebalancing, or else track my ongoing experiments with rebalancing in my test portfolios.
Rebalancing is not that hard, and any investor sophisticated enough to have any opinion on VT or AVGE whatsoever is also sophisticated enough for the simple alternative to AVGE that I explained above: equal parts AVUS, AVDE, and AVUV. If I start off with those, then the next time I have money to contribute, I can just add whatever I have to whichever of the three is lowest, and by doing so, ensure that I am purchasing what is the cheapest, relatively speaking.
If I have just five more minutes for rebalancing, I could add money to the two trailing funds to bring them up to the level of the lead fund, and then divide any remaining money equally between the three funds.
True, you could avoid this step with a deserted island equity fund like AVGE, but why? It’s not that hard, and you’d be costing yourself some flexibility and some expected returns.
Anyway, here are my thoughts on AVGE from a Risk Parity perspective:
- Although the performance data we have is way too recent to be definitive, I’d bet that AVGE will be better than VT, no matter how you slice it.
- Yes, its expense ratio is a wee bit higher, but I’d fully expect Avantis’s more sophisticated approach to factor-loading to pay off in short, medium and long terms.
- Vanguard’s funds are fine, and I understand their appeal, but it seems like everytime I put one of their funds against a “more sophisticated but with a slightly higher expense ratio” ETF, the other ETF winds up being better. I did this with IWY compared to VUG, with DFAX compared to VXUS, and AVUV compared to VIOV and VBR. AVGE looks that way, too. I love Vanguard and consider Jack Bogle a saint in the investing world, but honestly, investors can now do better.
- Still, I just don’t know if an all-in-one equity approach is the way to go. The “deserted island” idea doesn’t resonate with me, so really, I can’t see the rationale for going for VT or AVGE for that matter. What’s the full argument for agglomerating your assets in this way?
- Even sticking in the Avantis world, I’d guess that a AVUS/AVDE/AVUV combo would perform similarly to AVGE alone, plus you’d get the nice rebalancing opportunity. In a couple of years, it might be nice to go back and see how they have done. At this point, there isn’t enough of a track record, so these are just my guesses.
- Going beyond just Avantis funds, my previous investigations of "best in class" funds for US large-caps and Total International revealed that IWY and DFAX were better bets than AVUS and AVDE, so I'd go in that direction. Maybe like the distracted boyfriend.