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Five ETFs to build a diversified portfolio

13 March 2014

Nutmeg’s Shaun Port reveals five exchange traded funds that can help investors add diversification to their portfolio for a low price.

By Jenna Voigt,

Features Editor, FE Trustnet

Charges can have a big impact on your overall returns, which is why many investors turn to passive funds.

For investors who want to build a diversified portfolio for the lowest possible charges, Shaun Port, chief investment officer at Nutmeg, says exchange traded funds (ETFs) are the way to go.

“ETFs are incredibly efficient – they provide instant diversification, deliver the performance of a market very reliably and are incredibly low cost,” he said.

“These passive investment vehicles track an underlying index and aim to replicate the returns of the companies that make up the benchmark.”

Port says these cheap funds offer a good way for investors to build a well-diversified portfolio, able to withstand the majority of market conditions, as long as they know where to look.

“Constructing a simple portfolio with equity holdings in the UK, Europe, US and Japan and UK corporate bonds provides a great platform to build an efficient mix of investments,” he said.

“Combining the funds below – all of which are ‘physically backed’ so they own the constituents of a market index – the portfolio would hold in excess of 1,100 individual securities.”

“However, this mix would cost just 0.17 per cent per year in fund expenses (assuming a broad 60/40 equity/bond mix). All the funds are traded in sterling, to avoid paying any foreign exchange fees when trading these funds.”


UK: Vanguard FTSE 100 UCITS ETF – 0.10% TER

The first stop investors should make, according to Port, is close to home. He recommends picking up a core holding in the Vanguard FTSE 100 UCITS ETF.

“This fund provides exposure to the largest 100 companies listed in the UK,” he said.

“While the top-100 companies may be listed in the UK and traded in sterling, they derive a significant proportion of revenues from overseas (72 per cent on our latest estimate).”

The index tracker was launched in May 2012 and over that time it has mirrored the performance of the underlying index closely.

Performance of fund vs index since launch

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Source: FE Analytics


Over the last year, the Vanguard fund has actually outperformed the FTSE 100, returning 6.32 per cent.

The index made 5.73 per cent over this time.

The Vanguard ETF has tracked the FTSE 100 with an error of just 0.03 per cent over the last 12 months, according to FE Analytics.



Europe: DB X-trackers Euro Stoxx 50 UCITS ETF (DR) – 0.15% TER

One area investors may want to consider delving into, particularly as developed markets have rallied strongly, is Europe, where companies are still trading at cheaper prices compared with their historic highs.

For access to this region, Port recommends the DB X-Trackers Euro Stoxx 50 UCITS ETF, which beyond tracking the top 50 companies in Europe, has the added benefit of a 3.25 per cent dividend yield.

“This fund gives a diverse exposure to the top 50 companies in the eurozone, concentrated in Germany, France, Spain and Italy,” Port said.

The Deutsche Bank fund was also launched in 2012, in November. Since then it has made 29.69 per cent, broadly in line with the returns of its DJ Euro Stoxx 50 index benchmark, which made 30.42 per cent.

Performance of fund vs sector and index since launch

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Source: FE Analytics


Over the last year, the DB X-tracker has followed the DJ Euro Stoxx 50 index with a tracking error of 0.61 per cent.


US: HSBC S&P 500 UCITS ETF – 0.09% TER

The US is one country where active managers traditionally struggle to outperform the market, largely because it is such a developed and well-researched area of the world.

This is why investors are often better off choosing a cheap tracker to gain exposure to growth without paying for underperformance.

Port likes the HSBC S&P 500 UCITs ETF, with charges of a mere 0.09 per cent.

“This fund tracks the performance of the top 500 listed companies in the US, with a rock-bottom annual fee – just 90 pence for every £1000 invested,” he said.

Since launch in July 2010, the HSBC ETF has outperformed the S&P 500, returning 71.01 per cent.

The index made 65.72 per cent over this period.


Performance of fund vs sector and index since launch

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Source: FE Analytics


Since launch the fund has had a tracking error of 0.035.


Japan: iShares MSCI Japan GBP-Hedged ETF – 0.64% TER


Having covered the developed world in the West, the last equity ETF Port tips is the iShares MSCI Japan GBP-Hedged ETF, with slightly higher charges of 0.64 per cent.

“This fund provides the return on Japan’s top companies, but minimises the impact of any currency movements between sterling and the Japanese yen. While it is expensive for an ETF, we think it is worth paying for the currency hedge,” he said.

Over the last year the currency hedge has certainly paid off. While the MSCI Japan index lost 1.10 per cent, the tracker gained 18.57 per cent, according to FE Analytics.

Since launch in July 2012, the fund has made 64.56 per cent.

The index made 21.8 per cent over this period.

Performance of fund vs index since launch

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Source: FE Analytics


As the fund does hedge the currency, investors should not expect its performance to directly reflect that of the underlying index, but it does give investors exposure to Japanese companies while protecting against the depreciating yen.


UK corporate bonds: SPDR Barclays 0-5 Year Sterling Corporate Bond ETF – 0.2% TER


In order to keep a well-diversified portfolio, Port says investors need to have some exposure to fixed income as well as equities, which is why he likes the SPDR Barclays 0-5 Year Sterling Corporate Bond ETF, with charges of just 0.2 per cent.

“This fund invests in sterling corporate bonds with less than five years to maturity, providing better returns than cash but with much less interest-rate risk than a standard corporate bond fund,” he said.

With charges so low, Port says investors – particularly those with less capital – can add some real value to their portfolio through more exotic areas when they are ready to make a call on niche regions or sectors.

“To further improve the portfolio, the next steps we would take would be to add some spice to the mix by investing in funds tracking mid cap stocks in the UK (iShares FTSE 250 UCITS ETF) and the eurozone (iShares EURO STOXX Mid UCITS ETF). This would add a further 450 stocks at a cost of 0.4 per cent per annum.”

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