By
Morningstar
:
In economics, it is said that there is no such thing as a free
lunch, except perhaps diversification. Typically, one can not
achieve higher returns without taking on additional risk. However,
if assets are uncorrelated--some rising while others
falling--diversification can result in better returns without
taking additional risk. For the low cost of about 0.30%, this fund
provides a diversified, automatically rebalanced portfolio of
stocks and bonds.
Suitability
iShares S&P Aggressive Allocation (
AOA
) is a one-stop asset-allocation fund that holds both equities and
bonds, with a heavier weighting in equities given its aggressive
orientation. It is intended to serve as an investor's core holding,
either by itself or paired with a few alpha-seeking active funds.
For investors who do not have the time or inclination to research,
monitor, and rebalance multiple funds, allocation funds such as
this provide a simple and effective solution. The fund invests in
eight individual iShares ETFs covering domestic and international
stocks and bonds with a larger allocation toward stocks than bonds
to reflect its aggressive designation. One criticism of this
approach is that because investors often do not research the
underlying investments in an allocation fund, the portfolio can
sometimes be stuffed with lower-quality funds. That is not the case
here, as each of the component iShares products is high-quality and
follows a passive, index-based approach.
A key benefit to an asset allocation fund such as AOA is that it
automatically rebalances the portfolio for you. Rebalancing is a
key step in keeping a portfolio's risk within predetermined
parameters. Without rebalancing, a portfolio can quickly become
heavy in a trending asset class. For example, with rebalancing, a
50/50 stock bond portfolio has historically had a volatility of
return of about 11%. Without rebalancing, that volatility increases
to 16%. Because of behavioral biases, investors often fail to
rebalance in a disciplined manner. During the financial crisis,
when stocks sold off and rallied sharply, the prudent course of
action would have been to sell bonds and increase the allocation in
equities, but at the time, this would have been a unnerving
proposition.
For passive investors or those seeking to simplify their
portfolio decisions, asset-allocation funds such as this offer some
advantages to picking individual stocks or funds. For example, once
you decide on your risk-tolerance level, the fund handles all of
the asset-allocation and rebalancing decisions for you. A
rebalancing plan helps investors buy low and sell high as past
winners are trimmed and the proceeds are reinvested in past
losers.
Fundamental View
The financial crisis has forced investors to reassess asset
allocation and their own tolerance for risk. Many people close to
or in retirement realized that their exposure to stocks was too
large and resulted in too much volatility in savings. The S&P
500 has gained just 4.1% per year annualized over the last decade,
while the Barclays Aggregate Bond Index has gained 5.7% over the
same period. That does not mean that investors should rush into
bonds, particularly given the fact that equities are now more
reasonably valued than they were three years ago, and dividend
yields are in some cases higher than the historically low bond
yields. While many market prognosticators have said that we are in
a "bond bubble" it is also true that bond interest rates may remain
low for an extended period of time, much as they have in Japan.
While this fund should outperform bonds when stocks do well, keep
in mind that U.S. and international stock markets may move in
different directions. Investors not interested in trying to time
the market can take comfort in this fund's lower volatility and
balanced allocation approach.
Over the past three years, this fund has had a standard
deviation of 16%, about the same as the S&P 500's. One way to
interpret this number is that over a given year, you can expect the
fund to return within plus or minus 32% of its long term average
with 95% confidence. While the 19% allocation to bonds helps reduce
risk, emerging-markets and small-cap stocks increase it.
The beauty of a broad index approach followed by the component
ETFs in this fund is that investors do not have to have an explicit
view on the markets but are relying on the efficient-market
hypothesis, which suggests that, in aggregate, investors cannot
consistently beat the market on a risk-adjusted basis. This is why
active fund managers have a difficult time beating the market.
Proponents of the efficient market view, such as Eugene Fama and
Burton Malkiel, believe that indexing is the superior approach to
investing.
Portfolio Construction
The fund follows the S&P Target Risk Growth Index and is
composed of eight iShares ETFs: iShares Barclays Aggregate Bond (
AGG
), iShares Barclays TIPS Bond (
TIP
), iShares iBoxx H/Y Corporate HYG, iShares S&P 500 (
IVV
), iShares MSCI EAFE (
EFA
), iShares S&P MidCap 400 (IJH), iShares MSCI Emerging Markets
(EEM), and iShares S&P SmallCap 600 (IJR). These component
funds follow broad, passive indexes and the weighting in each is
rebalanced annually. Unlike target-date funds, which reduce risk as
the target date approaches, these funds are designed to maintain a
steady risk tolerance. Unlike the three other funds in this series,
AOA does not include iShares Barclays Short Treasury Bond
(SHV).
Fees
This fund charges a 0.33% expense ratio, which is about 0.11%
higher than the weighted average expense ratio of the underlying
funds. The additional 0.11% on top of the expense ratios of the
underlying funds is paid for the convenience of not having to
rebalance and for having only one fund instead of nine. We consider
AOA's expense ratio to be low, particularly when compared with
similar funds.
Alternatives
This fund is one of four iShares allocation ETFs, which range from
conservative to aggressive. These funds include iShares S&P
Conservative Allocation (AOM), iShares S&P Moderate Allocation
(AOK), and iShares S&P Growth Allocation (AOR). Each of these
funds charges 0.11% on top of the fees charged by the underlying
funds, and they invest in the same iShares funds as AOA but at
different weightings to reflect their varying risk tolerance.
Although the trading volumes in these allocation ETFs are
relatively low, the underlying ETFs that these funds invest in are
liquid. Investors should get good execution, but when trading large
dollar amounts, be sure to use limit orders and be patient.
There are many more asset-allocation fund options in the mutual
fund vehicle. Investors should examine our Fund Analyst Favorites
in the aggressive allocation category. One such fund with a four
star rating is the T. Rowe Price Personal Strategy Growth
((TRSGX)), though it has a higher expense ratio (0.77%).
Investors always have the option to invest directly in the
underlying funds. IShares also offers a series of target-date funds
such as iShares S&P Target Date 2040 (TZV), which is
constructed in a manner similar to this fund except that it will
reduce its risk allocation as the target dates approaches. These
products have not yet attracted significant assets. DBX Strategic
Advisors, a unit of Deutsche Bank, also offers target-date products
such as TDX Independence 2040 (TDV). TDV charges an expense ratio
of 0.65%, and although it invests directly in individual securities
instead of other funds, this fee is still greater than the combined
fee of the iShares offerings.
Disclosure:
Morningstar licenses its indexes to certain ETF and ETN providers,
including BlackRock, Invesco, Merrill Lynch, Northern Trust, and
Scottrade for use in exchange-traded funds and notes. These ETFs
and ETNs are not sponsored, issued, or sold by Morningstar.
Morningstar does not make any representation regarding the
advisability of investing in ETFs or ETNs that are based on
Morningstar indexes.
See also
Dunkin' Brands Group Management Discusses Q2 2012
Results - Earnings Call Transcript
on seekingalpha.com