A portfolio should always be balanced and include investments in different asset classes for broad risk diversification. ETFs also have their place in the portfolio.
Diversification with ETFs
With the help of ETFs, it's easy to diversify your own investments. By purchasing just a few ETFs, you can diversify across countries or asset classes where you would otherwise need to buy many different individual stocks. Core ETFs, such as those offered by Xtrackers, are particularly suited to the core of a portfolio. Xtrackers Core ETFs are a range of physically replicated (direct) ETFs with low fixed annual fees starting from 0.07% per annum. They are easy-to-use instruments that enable investors to build long-term portfolios profitably. Xtrackers' Core ETFs track major market indices, offering access to the main equity and bond markets. In addition, the Xtrackers Core ETF range includes various equity classes, including accumulation classes and currency hedging classes. This gives investors numerous options for achieving their long-term savings and investment goals. Xtrackers Core ETFs can serve as cost-effective building blocks for multi-asset portfolios, and are suitable for creating a broadly diversified portfolio at low cost.
For example, buying units of the Xtrackers MSCI World UCITS ETF provides diversification across around 23 industrialized countries and over 1,600 individual stocks. The Xtrackers MSCI Emerging Markets UCITS ETF offers diversification across more than 1,400 stocks in 18 current emerging markets. With these two index funds, investors can take advantage of the enormous growth opportunities in emerging markets, while also holding the less risky equities of industrialized countries in their portfolios.
However, diversification is still not perfect, as this ETF invests exclusively in equities. To further diversify the risk to one's own portfolio, other asset classes also need to be considered. Bonds are often added to a portfolio as a complement to an equity investment. They are generally less subject to fluctuations than equities, and also offer regular income in the form of coupon payments. However, even a broadly diversified portfolio remains exposed to general price and interest rate risks.
Investing in the global bond market with a few ETFs
However, selecting suitable bonds is not entirely straightforward, as attention must be paid to issuer creditworthiness, maturity and denomination. For many bonds, entry is only possible from several thousand euros, making a broadly diversified bond investment almost impossible for private investors.
Here again, core ETFs offer an alternative. The Xtrackers Eurozone Government Bond UCITS ETF, for example, allows investors to invest in over 300 different government bonds1 from the Eurozone. Attention has also been paid to the rating2 of the bonds included: the ETF contains only paper rated investment grade3 by the rating agencies. The counterpart on the corporate bond side is the Xtrackers EUR Corporate Bond UCITS ETF. It tracks the performance of over 2,000 euro-denominated corporate bonds. So, with just two ETFs, investors have the lion's share of the euro-denominated bond market in their portfolios.
Simple, inexpensive diversification
Investors who hold the above-mentioned ETFs in their custody accounts thus participate in the evolution of a large part of the global equity and bond market, without having to buy thousands of individual securities. The costs are also much lower than those for roughly equivalent diversification with individual securities. In the case of the Xtrackers Eurozone Government Bond UCITS ETF, the overall commission is just 0.09% per annum, and in the case of the Xtrackers MSCI World UCITS ETF, it is 0.19% per annum.
The workload and financial effort are therefore very low compared to active diversification undertaken by the investor, but the effect achieved is the same: broad diversification limits the risk of losses and increases the potential for returns, since the individual stocks held via ETFs are not all subject to the same risk factors and therefore react differently to different market conditions. However, investors should note that they remain fundamentally exposed to the general risks of equity and bond markets.
Portfolio ETFs – the engine of your portfolio
For investors who want to diversify their portfolios but are reluctant to select individual stocks or ETFs, or who simply don't have the time to research the stocks available, Xtrackers offers two interesting products: the Portfolio UCITS ETF and the Portfolio Income UCITS ETF. Xtrackers' Portfolio UCITS ETFs aim to make investing as easy as possible for investors, enabling them to easily place their assets in a wider range of equity and bond ETFs.
Portfolio UCITS ETF 1C follows a strategy aimed at maximizing returns, and can therefore potentially include a higher proportion of equity ETFs than its more security-oriented "little brother" Portfolio Income UCITS ETF 1D, which can also make regular distributions with a higher proportion of bond ETFs.
A strategy committee headed by Dr. Andreas Beck (graduate mathematician / Index Capital GmbH) meets several times a year to review and, if necessary, adjust the composition of the two Xtrackers Portfolio ETFs in line with current market conditions and anticipated developments. The Portfolio UCITS ETF pursues a strategy aimed at optimizing returns, and can therefore potentially include a higher proportion of equity ETFs than the more security-oriented Portfolio Income UCITS ETF, which also makes regular distributions with a higher proportion of bond ETFs1.
Both ETF portfolios aim to achieve maximum returns while limiting risk. The focus is on securities that generate regular income in their own right: primarily high-dividend stocks and bonds. These securities offer independent earning power through dividends and interest, in addition to income from price gains. In total, the ETF portfolio contains thousands of individual securities – far more than any private portfolio, even with the best diversification. However, investors should note that they are subject to price and interest rate risks, for example, as with any other capital investment.
What factor ETFs have to offer
Factor investing is based on the assumption that selecting stocks according to various factors, such as value, quality, momentum and minimum volatility, can lead to better performance than traditional benchmarks over the long term. Traditional indices weight stocks by market capitalization to reflect market performance, known as beta. In contrast, ETFs that use factor investing aim to improve investment performance through the use of factors, and achieve better long-term risk-adjusted performance than the pure market benchmark. Factor Value, for example, invests in stocks considered undervalued on the basis of fundamentals such as price/earnings1 or price/book2 ratios. Minimal volatility strategies, on the other hand, select stocks with the lowest index price fluctuation in mind. In addition, dividend and small-cap strategies (the so-called "size factor") can also be considered equity factors, as here too, the selection of index members is based on a particular style. Equal-weighted equity indices are a special case; here, it's much more a question of alternative weighting with the aim of achieving better risk diversification in the index than in the benchmark.
Development varies according to market phase
As factors develop differently in different market phases, it can be interesting for investors to set corresponding focal points with certain factor funds. For example, in a scenario of rising inflation and economic growth, the Minimum Volatility3 and Value4 factors were suitable. On the other hand, with falling inflation, Value and Momentum5 tended to be preferred. The historically low to negative correlation6 between returns is also important, which is why a dynamic combination of factors can improve risk diversification in the portfolio.
Many investors have been familiar with country and sector ETFs for some time. Factor ETFs offer another way of spreading risk across a portfolio. In the long term, therefore, they are an important part of portfolio construction. By using factor ETFs, investors also have the advantage of being able to flexibly compose an individual portfolio from different factors, according to their assessment of the market and their appetite for risk.
What's important to keep in mind?
Although the aim is to outperform conventional market benchmarks over the long term, this cannot be achieved in all market phases. Investors should therefore bear in mind that there may also be phases in which certain factors underperform the broader market. Although factor indices are broadly diversified, they use quantitative7 and fundamental8 approaches that considerably increase the complexity of these products compared to benchmark indices. This complexity and transparency also varies according to the fund provider. DWS works primarily with index provider MSCI on factor-based indices, in order to offer a high degree of transparency and representativeness. In general, however, factor ETFs are also only suitable for investors with a well-developed understanding of financial markets and fundamental analysis.
