The critical importance of understanding your investments: ETFs and analysing see-through holdings |

Understand the difference between ETFs and see-through holdings
What an ETF is and what an equity/stock holding is
Why ETFs over active fund management
How to download and consolidate your ETFs in a spreadsheet
An example of my portfolio broken down by ETF and holding

ETF’s overview and how they work

There are over 5000 exchange-traded funds (ETFs) globally and at least 1750 based in the United States.

The rise in what is called ‘passive’ investing since the Global Financial Crisis has been staggering. Ten years ago total investments through passive funds or ETFs were about 8% of the industry, split between ETFs and what are called passive mutual funds. As of 2017 that number jumped to 20% and accounts for $8 trillion in assets globally.

The lion’s share still sits within the active mutual fund management category:

The critical importance of understanding your investments: ETFs and analysing see-through holdings Frugal Investors

ETF stands for Exchange Traded Fund. These funds are a collection of stocks or equity investments that are typically listed on a stock exchange. The classic example and one of the highest volume ETF areas is the S&P 500 ETF that trades under the ticker SPY.

Key facts about ETFs

An exchange-traded fund (ETF) is a basket of investments that trade on the stock exchange as an individual investment
ETF stock prices change daily as they are bought and sold on the open market
ETFs are not just for stocks & shares; there are bond, commodity, and real estate ETFs
ETFs principally are cheaper than buying many different individual stocks one-by-one

Whereas a fund manager makes individual stock selections themselves or as a team, directing you to have shares in, say, Tim Horton’s owner Restaurant Brands International or Starbucks, an exchange traded fund simply owns large portions of the market based on set criteria. And when the criteria for the index changes, the fund that you own automatically changes too.

How this all works is best described through a graph of the fund (SPY), which is an exchange traded fund that owns the 500 biggest companies in the United States. As you could imagine, when the list of the biggest companies changes, so does the index. Most of this is done automatically.

Here’s the performance over the past ten years:

The blue line represents the ETF, SPY, which is an S&P 500 exchange traded fund. It owns the 500 largest companies in the United States by market cap. The red line represents the index – the standard that is owned centrally by a company that helps to run the stock market itself.

How it does that is straightforward. The reason that these are called ‘index funds’ is that they seek to replicate, as closely as possible, the performance of the underlying index. In this case the underlying index is the S&P 500. That’s the benchmark standard for the top 500 companies (technically 505 if you include double listings) in the U.S. and it represents 70-80% of the total market cap of the U.S. stock market. The index is managed by a company called S&P Global which is – interestingly enough – a constituent of the index!

Rather than individually picking stocks, the person who buys the S&P 500 index ETF is simply buying a large cross-section of U.S. companies, across the board.

Why ETF’s and not an Active fund manager that I can trust?

As Frugal Investors we aim to manage 100% of our investments, and to keep pace with the performance of the underlying indexes. While other investors try to ‘second guess’ the market, instead we simply track the market and cut out all of the advisors and middle-men in between.

If you look at the graph above, you can see a nice, upward sloping line from 2009. The S&P 500 has quadrupled since the bottom of the bear market following the Great Financial Crisis. The S&P 500 tracker (SPY) has achieved 97.5% of this performance, and the 2.5% of missed performance is due to something called tracking error, which I will cover separately. That’s a phenomenal performance.

How have active fund managers performed? According to AEI independent research, less than 8% of active fund managers beat the index. They conclude that over a 15-year period a staggering 95% of the time those active fund managers fail to beat the underlying index.

If you are looking to self-manage any part of your investment portfolio, then passive ETF’s that track the main indexes should be a key holding.

ETFs: See Through Holdings

If you understand the difference now between an S&P 500 index fund (SPY) and the underlying index, then great! This next part is a lot more straightforward.

An independent company sets the ‘list’ so to speak for the 500 largest companies in the US. A financial instrument called an exchange-traded fund follows that index and when you buy it, the fund allocates your money to these businesses.

The purpose of this article is to help you to understand what it is that you’re actually investing in.

The underlying holdings are the things that your money is actually invested in. For example, if you put 100% of your money into the tracker above (SPY), then I can tell you exactly what you own and how much of it you own as of today. That’s because all the ETF is doing is taking your money – say £10,000 – and automatically, without people interfering, allocating money to all of those 500 companies in agreed upon percentages that are directed by the index itself:

By investing £10,000 into a SPY ETF index tracker, you will own £429.60 in Microsoft, and £84.17 in Coca Cola as outlined above. When the underlying index weighting changes – say for example, Microsoft gets charged £150 billion for corruption – then the company drops down the rankings in terms of weight and less of your money is allocated to it. This all happens more or less automatically while you own the index fund as a product. In fact the weighting will have changed by the time you read this article!

ETFs: See Through Holdings – Home Base Portfolio

Let’s say, like me, you want to build a custom portfolio that is well balanced, gets good income every month and will not blow up the next time that a financial crisis rolls around. How do you buy multiple ETFs and then still retain the ability to have a look at your see-though holdings?

Here is another example portfolio of ETF’s and how they help you to own individual shares without as much work. Here is my current U.K. Portfolio (you can read about the detail here):

Vanguard FTSE 100 tracker – VUKE
Vanguard FTSE 250 tracker – VMID
SPDR S&P Global Dividend Aristocrats UCITS ETF
Vanguard FTSE All-World High Dividend Yield UCITS ETF
SPDR S&P Euro Dividend Aristocrats UCITS ETF
Vanguard Lifestrategy 100% Asset Allocation ETF

Now just to re-cap: each of those ETFs owns hundreds, and in some case, thousands of businesses in their individual asset categories. The first two are U.K. centric, the third and fourth are global dividend funds, the fifth is a European dividend fund, and then finally the Vanguard life strategy fund is a balanced pension product that owns a diverse set of shares across the globe.

The principle is the same. Instead of one ETF (SPY) we now have 6 ETF’s that are invested in different portions of the stock market. This particular portfolio has concentrated holdings in Europe and quite a high dividend yield.

In order to undercover what my ‘underlying holdings’ are, I’ve downloaded the holdings for each of the 6 ETF’s and then used Excel to put them together in one single list. Here it is:

The key take-away is that these aren’t abstract concepts; the ETF’s own individual shares, and it is worth taking a look underneath and seeing what you actually own. In this case you can see a good balance of UK shares (HSBC, BP, Shell) and American shares (Microsoft, Apple, AT&T) alongside European conglomerates (Bayer, EDP, Total SA).

How to Build a Portfolio

There are ample ideas and model portfolios on this website that you can use as the basis for your research.

In addition to the Home Base Portfolio, referenced above, we have a few other model portfolios.

Have a look at the gold-rated Vanguard LifeStrategy asset allocation ETFs (if you’re based in the UK).

Have a look at the gold-rated Vanguard Growth ETF or related asset allocation ETFs (if you’re based in Canada).

If cheap, worldwide diversification is what you are after perhaps consider an MSCI World Index tracker fund.

We are in the process of building a Global Dividend Aristocrats set of funds and passive investments as well.

Final Thoughts on Passive Investing

The game is pretty straight forward: avoid losing money and buying into investments that perform poorly over long-time periods (10+ years). There are a lot of scams out there and you need to be careful and vigilant with your money. Instead of trying to ‘become a fund manager’ and focusing daily on investing in individual shares, you should instead put time into accelerating your career and earning more money with which to save!

The universe of passive funds is absolutely colossal. You can use passive funds (ETFs) to invest in everything from Bitcoin to Lithium to betting on the direction of interest rates.

At Frugal Investors we believe that investors should take their time and ensure that they invest in balanced ETFs with long histories and periods of established performance.

When we reference the S&P 500 index it is a time-tested and established benchmark for the US stock market. Equally the FTSE All Share index is the British equivalent and it forms the cornerstone of the UK stock market. Try to use these indexes either as direct investments or as benchmarks for what you want to invest in.

Try to stray away from tantalizing investments that do not have 8-10 years of performance figures for you to analyse. The following investments sit in the riskier category of funds and should be avoided altogether (or used with caution):

Bitcoin or any cryptocurrency funds
Lithium or electric car funds
Quantum computing, AI or artificial intelligence related funds
Real Estate and property funds unless they’ve been around for 10+ years and have £ or $ billions invested in them with stable income pay-outs for at least 8 years
Autonomous vehicle technology companies
Space flight and exploration companies

The list goes on. Be cautious and make sure that whatever ETFs you invest in have a long history of performance (8-10 years), invested assets of £1 billion ($1.7 billion), and they are meeting or exceeding the performance of their underlying indexes.

From one Frugal Investor to another – happy investing!