The Best Investment For Conservative Investors I’ve Ever Seen
I bet most investors, even risk-tolerant ones, would be fibbing if they said they weren’t nervous at all right now.
#-ad_banner-#With so many top analysts, economists and money managers saying we’re due for a big correction or extended rough patch in stocks, who wouldn’t be at least a little jumpy? (I am, and I have very high risk tolerance.)
With plenty of fear to go around, many investors probably wouldn’t mind injecting a good dose of safety into their portfolios — something a lot more conservative but still able to earn a decent return. With interest rates so low, cash, CDs and bonds won’t do — not on their own, anyway.
Certainly, it’s necessary to have at least some exposure to stocks, but how much? And to what kinds? For instance, should there be exposure to foreign stocks, or are these too risky? What ratio of fixed-income and cash is appropriate?
Clearly, investors seeking greater safety have many questions to consider. Fortunately, I’ve found an investment — an exchange-traded fund (ETF) — that I think has all the answers.
This ETF hasn’t been around that long but plenty long enough to prove its mettle, in my opinion. In fact, a well-known ETF provider began offering the fund just over five years ago (in late 2008, right around the time the U.S. financial system looked ready to collapse.)
As a member of the conservative allocation category, this ETF tracks the S&P Target Risk Conservative Index, which emphasizes fixed-income to help preserve capital and limit volatility. Yet it provides just enough equity exposure to generate that decent rate of return I mentioned. The ETF I’m referring to is iShares Conservative Allocation (NYSE: AOK) — and to my thinking, it has everything a conservative investor could want.
According to the latest iShares fact sheet, here’s the fund’s composition by asset class:
The strategy to achieve this asset allocation is extremely simple — the fund holds a basket of iShares ETFs corresponding to each asset class. For instance, iShares Core S&P 500 (NYSE: IVV) represents domestic large-cap stocks, while a handful of ETFs provide diversified exposure to domestic bonds. The iShares Core Total Aggregate U.S. Bond (NYSE: AGG) covers the overall bond market and iShares TIPS Bond (NYSE: TIP) provides exposure to Treasury inflation-protected securities (TIPS), U.S. government bonds designed to blunt the effects of inflation.
All told, AOK is made up of nine iShares ETFs:
As both tables illustrate, equities make up barely a third of AOK, below the category average of 35%, while bonds account for just over two-thirds. Because of this highly conservative asset mix, the fund is typically 60% less volatile than the overall stock market.
Although many investors remain especially wary of European stocks because of that region’s economic troubles, I like AOK’s 12% position in iShares MSCI EAFE, an ETF that tracks developed equity markets outside the U.S. and Canada (Europe, basically). As I noted earlier this month, European stocks are poised to rebound, so shareholders in AOK would benefit because of the fund’s meaningful exposure to the region.
Individually, the fund’s small-cap, mid-cap, and emerging markets equity positions are unlikely to have a very noticeable impact on returns. But together they occupy nearly 5% of AOK — a position large enough to boost performance when these assets outperform, but not so large as to increase risk substantially.
I like the fund’s nearly 8% position in iBoxx High-Yield Corporate Bond for a similar reason. (My colleague Michael Vodicka is also high on HYG.) So-called junk bonds typically provide better long-term returns than TIPS, short-term Treasurys and the bond market in general. But here again, the fund’s position in them isn’t large enough to present significant risk issues.
Total returns have been very solid for such a tame investment, averaging 7.8% a year for the past five years, 33 basis points more than the category average. Fund costs are rock-bottom, as shown by an expense ratio of 0.29.
Risks to Consider: Though very conservative, AOK isn’t risk-free. For example, rising interest rates could adversely affect the value of the fund, particularly its bond holdings.
Action to Take –> Many investors are understandably worried about a sudden large pullback in the market or an extended rocky period for equities. Many others are simply conservative by nature and want to play it safe regardless of what’s going on with the economy. In both cases, AOK is a top choice for reining in risk while still having a good shot at solid returns.