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portfolio strategy

The biggest chunk of portfolios robo-adviser Wealthsimple offers to cautious investors is a bond ETF that fell sharply in the past two years and could lose more.

Robo-advisers are a great option for investors willing to pay a modest fee to have pros build and maintain a portfolio of exchange-traded funds for them. But Wealthsimple’s liberal use of the BMO Long Federal Bond Index ETF (ZFL-T) shows the importance of staying on top of what’s in your portfolio and understanding why.

ZFL holds bonds issued by the federal government and its agencies that mature in 10 to 30 years or more. They offer higher yields than shorter term bonds, but their prices are more vulnerable to rising interest rates. ZFL’s cumulative 11.4 per cent loss in the past two years reflects the fact that rates in the bond market have soared from their pandemic lows.

According to information posted on its website, Wealthsimple devotes 37 per cent of its conservative portfolios to ZFL or similar funds, and 30.5 per cent of the balanced portfolio. The balanced portfolio is shown as a rough 50-50 split of stocks and bonds, which means it’s for cautious investors willing to sacrifice some upside to moderate the crunch of falling stock markets. The conservative portfolio is even tamer, with a stocks-bonds split of 35-65.

There are bond ETFs that seem better suited than ZFL to providing core bond market exposure in a portfolio because they offer the diversification of short-, medium- and long-term bonds, and bonds issued by the federal and provincial governments, as well as financially strong corporations. For example, there’s the BMO Aggregate Bond Index ETF (ZAG-T), down a cumulative 2.3 per cent in the two years to Feb. 28.

Why ZFL, then? Surprisingly, Wealthsimple chief investment officer Ben Reeves said it’s all about playing defence. “Our portfolios are intended to underperform in booms and outperform in busts,” he said.

Mr. Reeves’ reasoning is based on the fact that the balanced and conservative portfolios also have significant exposure to short-term corporate bonds. These bonds offer more stability than ZFL when rates rise, but minimal upside potential if rates were to fall. ZFL struggles when rates rise, but offers much more upside if the outlook for the economy sours.

Guess what’s happening now. Russia’s invasion of Ukraine has created doubts about the global economic outlook and caused rates to retreat a little. The price of ZFL had a modest run higher after the invasion started late last month, though it has since pulled back.

The more the outlook for the economy and markets worsens, the better for ZFL and Wealthsimple clients holding portfolios with a big position in this ETF. As for the performance of these portfolios when there’s optimism about the economy and stocks, we only have to look at the past two years to get the gist.

Wealthsimple’s balanced portfolio had a one-year gain of 1.3 per cent to Feb. 28 and a three-year annualized return of 4.6 per cent. For a comparison, let’s use an ETF that provides a fully diversified 50-50 portfolio of stocks and bonds in a single package. The Horizons Conservative TRI ETF Portfolio (HCON-T) had a one-year gain of a tick below 4 per cent and an annualized three-year return of 9.1 per cent.

Part of the performance deficit for the Wealthsimple portfolio return is accounted for by a portfolio management fee of 0.5 per cent. Another factor is the use of ZFL and a short-term bond ETF instead of a plain old broad-based bond ETF like the one in HCON.

The truth of robo-advisers is they all do the same basic thing – build you a portfolio of low-cost ETFs and manage it for you over the years. But Wealthsimple’s use of ZFL highlights the way portfolio-building philosophies can differ. Other firms tend to use at least some of a broad-based bond ETF, sometimes augmenting it with another fund or two.

Robo-advisers have real, live people you can talk to and it’s a good idea to consult them if you have questions about how and why your portfolio was built. Judge robo portfolios by the fees and whether the strategy at work makes sense to you. Recent performance is not much to go on.

“No matter which portfolio you’re holding, it is generally going to be a mistake to switch based on short-term performance,” Mr. Reeves said.

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