Vanguard LifeStrategy funds offer a cheap way of getting a global, diversified portfolio that has a fixed level of risk which is determined by the share component of the portfolio. Vanguard offers 20%, 40%, 60%, 80% and 100% equity portfolios at a very low ongoing cost of 0.22%. Most of all LifeStrategy funds offer simplicity: you don't need to worry about rebalancing or asset allocation.
Sometimes you come across something that seems too good to be true, and when I first saw Vanguard's LifeStrategy funds I had exactly that feeling. What caught my eye is that the management fee is extremely low: 0.22%. So what's the catch? In this review we will look at what you're offered with Vanguard LifeStrategy funds, and also the risks you take by buying them and their drawbacks.
Vanguard LifeStrategy fees are very low
Let's start off with the fee. A total expense ratio (TER) of 0.22% means that if you invest £10,000 you will pay Vanguard £22 each year. For comparison, my broker Barclays has a list of funds which it describes as follows: "Chosen by Barclays’ investment specialists, we believe these funds have the right characteristics to outperform the market over the medium to long term". The annual ongoing charge ranges from 0.56% to 1.12% i.e. twice to five times the fee for Vanguard! So these Vanguard funds are cheap.
The sting in the tail is that my broker, Barclays Stockbrokers, charges 0.35% per year in a "Fund Administration Fee" which more than doubles my cost of owning the fund. Other UK brokers also charge this fee: for example A J Bell charges 0.2% per year on fund assets up to £1 million and Hargreaves Lansdown charges 0.45% on the first £250k then 0.25% from £250k to £1 million. That's why Vanguard has recently opened its own website where you can buy their funds and hold them with an administration fee of just 0.15%. When this news broke shares in Hargreaves Lansdown fell sharply and it is likely to force other platforms to cut their fund administration fees.
Fund Name | TER (%) | Total Assets (£ mn) | Volatility (%) |
|---|---|---|---|
LifeStrategy 20% Equity Fund | 0.22% | 578 | 4.3% |
LifeStrategy 40% Equity Fund | 0.22% | 1658 | 5.2% |
LifeStrategy 60% Equity Fund | 0.22% | 2504 | 7.4% |
LifeStrategy 80% Equity Fund | 0.22% | 1187 | 10.0% |
LifeStrategy 100% Equity Fund | 0.22% | 564 | 12.7% |
LifeStrategy Myths
There is no entry or exit fee for Vanguard funds if you buy them through a broker. Institutional investors such as pension funds and hedge funds who buy and sell in huge amounts may have to worry about this, but small investors do not. Another source of confusion is the minimum size of investment. Again, if you buy through a broker there is no minimum investment other than the cost of each fund which is around £130 to £200 depending on which LifeStrategy fund you are buying. This could be made clearer on the Vanguard LifeStrategy prospectus and website.
LifeStrategy Fund Choices
Vanguard offers five LifeStrategy funds which are graded according to the amount of equity and fixed income they contain. These are multi-asset funds which means that they combine different asset types: shares and bonds. The risk of shares is generally much higher than bonds. For example if you buy a fund that tracks the UK FTSE 100 the typical price move is 17% per year. That means that you should not be in the least surprised if in one year you lose almost a fifth of your capital. For comparison the volatility of a UK fund that buys UK government bonds (iShares IGLT) is just 7% which means that a typical loss or gain is less than half as much as the FTSE 100.
The key thing to remember is that portfolio risk is dominated by equities. The more equities a portfolio contains the greater its risk. That's why as you add more equities to the Vanguard LifeStrategy funds the volatility increases from 4% for the "20% Equity" fund to 13% for the "100% Equity" fund. Here is a diagram showing the gradual increase in risk from the 20% Equity fund to the 100% Equity Fund.
One of the helpful things which robo funds provide is a way of gauging your risk appetite, which they measure with a brief questionnaire. They then match your risk appetite to a portfolio with an appropriate risk profile. The more risk you take the greater your potential reward and your potential loss. Remember:
Higher risk does not guarantee higher return, it allows for the possibility of higher return.
If you want to get a feel for the risk profile of each LifeStrategy fund and to assess which would be suitable for you it may help to consider the typical loss you would be willing to accept. How much would you be willing to lose in a typical year? If your acceptable loss is 4% then the 20% equity fund might be most appropriate. If your acceptable loss is 13% or more then the 100% equity fund might be more appropriate. To gauge the popularity of each fund the table above shows the total assets of each fund. The LifeStrategy 60% Equity fund is most popular.
What return should you expect?
Risk and return of Vanguard LifeStrategy funds. Based on returns over the period from 2011 to 2017. vg20 to vg100 are the 20% equity to 100% equity funds and spx is the S&P 500 index.
Why are we talking about risk and not return? The two are related, as you can see in the graph above: the higher the risk of the fund (further to the right of the plot) the higher the return (further up the plot). Surely what matters is the return of each fund? Unfortunately the data for these funds covers the period from mid 2011 and as we will see later the equity component of the LifeStrategy funds is heavily exposed to US stocks which have had a blistering rally over this period. If we compare the correlation of daily returns for the five LifeStrategy funds with the S&P 500 we can see that their returns owe a great deal to this rally. The correlation of the daily returns of the 60%, 80% and 100% equity funds with the S&P 500 are all around 0.7 which is very high. If there is a significant equity market correction the 100% equity fund will suffer most, but as there has been no large correction since 2011 expecting returns of this magnitude over the long-term would be optimistic.
| 20% Equity |
40% Equity |
60% Equity |
80% Equity |
100% Equity |
S&P 500 |
|---|---|---|---|---|---|---|
Annualized Return June 2011-May 2017 (%) | 5.1% | 6.4% | 7.7% | 8.9% | 10.0% | 11.1% |
Correlation with S&P 500 | 0.13 | 0.53 | 0.68 | 0.72 | 0.73 | 1.0 |
Return of S&P 500 since 1871 is 4.4%, post-WW2 is 7% so expecting 11% return per year in future would be optimistic
If we also factor in the effect of reinvesting dividends the real total return of the S&P 500 goes up to 6.9%. That should calibrate your expectations for the long-term performance of the US stock market, and developed market shares in general. It also highlights the unusually high returns which we have had in the period from 2009 to 2017.
This is what the value of £10,000 would look like if you invested it in the five Vanguard LifeStrategy funds in June 2011. The purple line at the top is the S&P 500 US stock index which outperformed them all. You can see this period is one in which US equity performance has been amazing. If we have a US stock correction, however, the benefits of a diversified portfolio will suddenly reveal themselves because the LifeStrategy fund will lose less than the S&P 500. That's why you would pay your fee of 0.22% for a diversified fund rather than 0.07% for a Vanguard S&P 500 tracker.
What's in the funds?
Vanguard has the advantage that it can buy its own equity and bond funds. These are run according to the Vanguard standard of efficiency and are very low-cost. This efficiency percolates up to a low management fee for the multi-asset LifeStrategy funds. For example if we look at the 20% equity fund Vanguard gives the following allocation. Vanguard, Vanguard, Vanguard... they're all its own funds!
The dominance of US shares in all the funds is clear. For the 100% and 80% equity portfolios US shares constitute about 40% of the allocation. The dominance of US stocks may reflect the large size of the US stock market, which is by far the biggest globally. Buying stocks of companies with large market capitalisation ensures that Vanguard can keep trading costs down and pass that saving on to its customers. In bond allocations the dominant fund is the Vanguard Global Bond fund which makes up a fifth of the allocations for the 20%, 40% and 80% funds.
Here is Vanguard's visualisation of what's in the LifeStrategy funds. The dominant allocations are to Global Developed Equity in dark grey and Global Bonds in sky blue. But as these are tweaked for the UK they have a fairly large allocation to UK equity in beige, far higher than the UK's slice of the global share market.
Fixed Allocation Strategy
Asset allocation strategy is how you set your portfolio's long-term asset mixture. There are many approaches. Some look only at risk, which is the approach adopted by minimum variance funds, the asset allocation algorithm behind Scalable Capital, and Bridgewater and other managers' risk parity funds. Some strategies follow trends, buying assets which display a rising price trend and selling assets that which are falling. All these approaches have merit. Fixed asset allocation, as adopted by Vanguard LifeStrategy funds is simple. That's really the best that can be said about it.
For example in an environment where equity is very clearly entering a crisis, as it did in the Global Financial Crisis in 2008/9 there was time to reduce holdings of shares and buy bonds. Volatility in shares rose well before the big selloffs. However a fixed allocation would simply ignore this evidence and continue buying more equity as its price fell and selling safe government bonds in order to level off the allocation of the portfolio. Another example might be a spike in interest rates. There may be clues given by the central bank that it is going to raise rates sharply, or clues from rising inflation that this would force the central bank to raise rates. It would make sense to reduce the allocation to government bonds if this were the case. However a fixed allocation would ignore the evidence and buy more bonds as their price fell to rebalance the portfolio. In short fixed allocation is a dumb strategy. So dumb, in fact, that we'd consider it a risk.
What's the duration?
I tried to find the duration of the LifeStrategy funds on the Vanguard website, but could not find them. Perhaps I was looking in the wrong place, but frankly this should not be hard to find. The reason why is that knowing a fund's duration tells you a great deal about its interest rate risk. If a fund contains a lot of bonds with long maturities then it will have a relatively high downside risk if interest rates were to rise. A fund duration of ten years means that if interest rates rise 1% your fund's price will fall by 10%. A fund with a duration of one year would only have its price fall by 1%. This is something I want to know!
The excellent Morningstar website did have some information on duration: all the funds other than 100% equity (which has no bonds) have a duration of around 9 years. That suggests a considerable interest rate risk, which should be flagged.
This article explains all about duration and why it affects your investment risk:
Could you create a DIY LifeStrategy?
Given the simplicity of Vanguard's approach could you be better off trying to replicate Vanguard's strategy yourself. If there wasn't a Fund Administration fee added by brokers for holding Vanguard funds the answer would be a resounding "no". Given the fee the answer is an uncertain "no". The two principal reasons why you could not replicate LifeStrategy funds is a combination of human nature and trading costs.
Let's start with human nature. Can you guarantee that you will regularly rebalance your portfolio? Life gets in the way of all such good intentions, and like a New Year's resolution this is one that you would probably let slide. Rebalancing is a tedious chore. Also it is against our nature to sell funds that are performing well and buy funds that have performed badly, which is what we must do in order to rebalance and bring our portfolio back into line with our fixed strategy.
Secondly we have to consider transaction costs. While a huge asset manager will get very competitive pricing from brokers we would not. As a proportion of the amounts we trade the costs of trading is much higher. This effectively makes it impossible for us to rebalance cost-effectively if we rebalance frequently. The only thing we would have in our favour is that individual Vanguard ETFs would not carry a fund administration fee.
Using LifeStrategy to make a robo fund
LifeStrategy ticks a lot of the boxes for a robo adviser offering. It creates the core of what the robo adviser provides which is a set of risk-graded funds that are diversified, rebalanced and relatively inexpensive. However LifeStrategy funds don't help you match your risk appetite and risk capacity to a fund with an appropriate level of risk. Also robo advisers usually provide their own platform that holds your investments and lets you track their performance. There are clearly some gaps that you need to fill to make your own cheaper version of a robo fund. That's why we've made a course that explains how to fill these gaps:
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