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DIY portfolio-building works better than these funds

New investors should think seriously about opting for low-fee balanced funds like those offered by Mawer, Steadyhand, and PH&N. They represent good picks for active investors.

Regrettably, there are relatively few balanced options that are worth recommending to index investors. But I'm always on the look out for good alternatives, which is why I was intrigued to learn of a new series of funds launched by BlackRock. The new offerings were brought to my attention when I had the pleasure of taking readers' questions during a Q&A session at GlobeInvestor.com (you can read it here: http://tgam.ca/Dz2Y).

BlackRock's funds aim to achieve a preset asset allocation of stocks and bonds, but its managers have a good deal of latitude when deciding on the specific market slices to invest in while using the firm's exchange-traded funds (ETFs) as building blocks.

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The company is offering seven funds designed for investors with different risk tolerances in mind. They range from the low-risk All Bond Portfolio to the high-risk MaxGrowth Portfolio.

When looking at their holdings, I was pleasantly surprised to see only a few ETFs in each fund. Simplicity is a virtue when it comes to passive investing, and some complicated balanced index funds are larded up with more than a dozen ETFs.

On the downside, the new BlackRock portfolios contain a few oddities, and the distribution of geographic risk is one of them.

The Balanced Portfolio is set up as a moderately risky fund, 40-per-cent fixed income plus 60-per-cent stocks. Its mandate is to put roughly 20 per cent of its assets in international equities. The fund accomplished this by placing 15 per cent in emerging markets and 5 per cent in the developed markets of Europe, Australasia and the Far East (EAFE) at the end of January.

Holding three-quarters of its international equities in the emerging markets represents an aggressive bet. It's a sharp departure from market-capitalization weighting, which would assign more to the developed markets. As a result, the fund's managers demonstrate that they are quite keen on the prospects for the emerging markets – in this case.

But when you turn to the most aggressive all-stock MaxGrowth Portfolio, you'll find that it devotes 20 per cent of its assets to the emerging markets and 14 per cent to EAFE. Here, the relative bet on emerging markets is far smaller than that for the balanced fund, even though the overall weighting to international stocks is higher.

I'm not sure what to make of the contradiction. But BlackRock thought it would not be an issue because they expect the minimum-volatility ETFs used by the Balanced Portfolio to be less risky (and have lower expected returns) than the regular ETFs used in MaxGrowth.

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Many of the new funds also hold specialty ETFs, such as the iShares S&P/TSX North American Preferred Stock Index Fund (XPF) and various minimum-variance ETFs, but they come with tax consequences. Some of these ETFs are best put in taxable accounts while others are better suited for tax-sheltered accounts. As a result, many investors would be better off splitting up the fund's holdings for tax reasons, rather than holding the package.

Then, there is the matter of fees, which are higher than most passive investors would like.

BlackRock estimates that the MER (annual fee) of its Balanced Portfolio will be 88 basis points on the D series of funds designed for do-it-yourself investors. The costs should climb to 172 basis points on the A series of funds used by advisors.

Investors can save on the fees – and better optimize their portfolio to avoid the long arm of the taxman – by unbundling the funds and buying the underlying ETFs directly. The Balanced Portfolio holds just nine ETFs and replicating it would cost a blended MER of about 33 basis points annually, plus a few trading commissions. Frugal index investors could lower the costs even more by sticking to lower-fee broad-market ETFs instead of the specialty ETFs used by the fund.

As a result, these funds aren't quite what I'm looking for.

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About the Author

Norman Rothery, Ph.D., CFA, is the founder of StingyInvestor.com and has been catering to value investors since 1995. He publishes the Rothery Report, a value stock newsletter. Norm obtained a Ph.D. in atomic physics from York University before following his passion for investing. More

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