Investment Workshop 56: How Does the WealthSimple Portfolio Stack Up?

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Wanderer

The Wanderer retired from his engineering job at a major Silicon Valley semiconductor company at the age of 33. He now travels the world, seeking out knowledge from other wealthy people, so that he can teach people how to become Financially Independent themselves.

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Last week, we took a look at WealthSimple’s user interface. Since the entire point of Robo-Advisors is to be user-friendly, I was expecting a pretty, easy-to-understand flow and in this case, WealthSimple didn’t disappoint. But to be honest, pretty much every Robo-Advisor is user-friendly. A Robo-Advisor that opens up with a view of complicated charts and spreadsheets wouldn’t last 2 days in this space before going down in flames.

But we do know that behind that user-friendly sheen is the crux of WealthSimple’s value-add: Their portfolio design engine. How does WealthSimple take those responses from the questionnaire and translate that into an investment portfolio, and is that investment portfolio any good?

That is the question that we will attempt to answer today. Ready to rock and/or roll? I know I am!

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Overall Strategy

In my investing career, I’ve sat through countless pitch meetings with finance people, and the meeting usually goes something like this.

“So how do you build your clients’ portfolios?”

“It’s a proprietary strategy we’ve created.”

“And how does it work?”

“Oh, I can’t tell you the specifics. But rest assured some very VERY smart people have worked on this.”

*angry sigh*

This is the dilemma of being in the financial advisory business. If you’re TOO transparent, then your customers can just build the portfolio themselves and cut you out of the picture. But if you’re too mysterious, the customer won’t trust you. Unsurprisingly, most financial advisors tend to err on the side of mystery, and try to razzle-dazzle you into believing that THEIR sorcery is better than the OTHER GUY’S sorcery.

So I was kind of half-expecting that WealthSimple would be similarly evasive when asked about how they built their portfolios. Surprisingly, they were relatively straightforward about it, explaining it in this helpdesk article. Basically, they describe their strategy as boiling down to three principles:

1. Diversification. Basically, their strategy is to achieve massive diversification by using ETF’s rather than individual stocks. So far so good.
2. Passive Management. They extoll the virtues of passive management via indexing vs. active management via stock picking. Interesting, interesting.
3. Risk Customization. They use the results of that quiz to figure out your target allocation, so every portfolio is customized to your risk tolerance.

So as it turns out, WeathSimple’s investment strategy is not unlike ours: A passive investing strategy based on Modern Portfolio Theory and using low-cost Index ETFs as the building blocks.

This is also, by the way, in my opinion the most effective, safest and, most importantly, reproducible way to invest in the stock market, so I’m on board. So now, let’s dig into the weeds a little bit and peek under the hood to see how their system puts all the pieces together.

What’s Your Target Allocation?

There are many ways of determining your portfolio allocation, and none are perfect to be honest. Many traditional financial advisors use age, which of course assumes traditional retirement age. I like to use time to projected early retirement, but that requires a full case study analysis with lots of inputs to figure out. WealthSimple uses “risk tolerance,” which is nice for them because it simultaneously sounds smart yet is ambiguous enough that they have plenty of wiggle room in case they get it wrong.

Basically, the results of your quiz comes out to a risk “score” between 1 and 10. 1 being the most risk averse and 10 being a volatility-loving cowboy. Based on that score, it maps to a 10 pre-determined portfolio allocations, which are the following.

Or, if you want to see it in pretty chart form…

So from here, we can see that generally, a lower risk score means less equity and more fixed income, while a higher risk score means more equity and less fixed income. That makes sense.

We can also see that it’s not a straight line, so they somewhat tweaked their models a little bit. They don’t appear to be comfortable going less than 30% equity/70% fixed income even in the most conservative portfolios, and their riskiest portfolio tops out at 90% equity/10% fixed income.

It’s also important to note that the questionnaire only sets out your initial portfolio allocation. You may fill out the quiz and disagree with the results, and that’s fine. If you want to ignore what WealthSimple says your risk tolerance is, and instead want a certain portfolio allocation for whatever reason, just look at the above table, figure out what risk score corresponds to that allocation, and drag the risk score slider to that number in your account.

What Kind of Portfolio Do They Build?

So now that we have our target allocation, what does their actual ETF selection look like? Well, for me when I filled out my quiz I got a risk tolerance of 5, which conveniently corresponds to a 60% equity/40% fixed income allocation. This is nice in that I’ll be able to compare WealthSimple’s portfolios directly to what I advocated in our Investment Workshop. Like our Workshop, WealthSimple has a Canadian version and a US version of their portfolios, so we’ll take a look at each below.

Canada

For our 60/40 portfolio, we used a relatively simple portfolio based on the Canadian Couch Potato model, which was essentially this:

So basically, the bonds are just contained in an aggregate bond fund, with the equity portion split up evenly between Canada, US, and International, with a tiny bit of emerging markets sprinkled in. Pretty simple, just 5 funds. Now let’s look at WealthSimple’s 60/40 portfolio.

So what do we notice here? Well, obviously, the WealthSimple portfolio is more complicated, clocking in at 9 ETFs vs. our workshop’s 5. But what do we get with this complication, and what is WealthSimple trying to do that’s different from a more plain-vanilla indexed portfolio?

Let’s take a look at their fixed income holdings first. You can tell a lot about how someone sees the future direction of macro-economic trends based on what kind of bonds they hold. The Workshop’s holdings of VAB, which just holds all bonds equally, is a sign that we don’t really have much of a strong opinion at all about which way macroeconomic trends are going.

WealthSimple, on the other hands, splits their core bond holdings across a ZFL, QTIP, and ZDB. ZDB is a discount bond ETF, and without getting into the weeds of how discount bonds work, it’s basically trying to lessen tax impact by exchanging highly taxed interest income with more efficiently taxed capital gains. ZFL is a long bond ETF, which means it holds bonds that have a longer duration, on average in this case about 16.65 years. The reason why you would go long on your bonds is that you believe that interest rates will drop in the future, because that would cause long bonds to go up in value. And finally, QTIP (heh heh) is a U.S. Treasury Inflation Protected (TIP) bond fund, which has a floating coupon rate that’s pegged to inflation. If inflation goes up, it’s interest rate (and fund value) will rise to keep up.

So we can tell here that WealthSimple believes in the near-to-medium term, they believe that U.S. inflation will continue to rise, while interest rates will continue to fall. Given that next year is an election year and Trump has, in the past, bullied the Federal Reserve to lower interest rates in order to keep the stock market buoyed, that might explain why they took this position.

Now, onto the equity side.

It’s not as clear where their money is spread out geographically because there are overlapping holdings (in particular, ACWV), but we can pick out a few clear differences in their holdings versus ours. First, they are far less weighted in Canada, but far more on emerging markets. You could argue that this is more reflective of the market sizes of each country since Canada is a relatively small player on the global stage, but personally I’ve always been nervous about adding too much weight to emerging markets because of their markets tend to be less well regulated and transparent, but to each their own.

And secondly, WealthSimple uses some low-volatility ETFs while we stick with straight indexes. Low-volatility ETFs attempt to cherry-pick stocks out of an index that are less volatile than the overall index, resulting in lower day-to-day price movements, but lower longer term performance.

So with all that being said, how do the two portfolios stack up side-by-side. For that, we go to our old friend PortfolioVisualizer.com.

I put in the Workshop portfolio as well as the WealthSimple portfolio into the Portfolio Backtest tool, with one exception. For some reason, it didn’t have any price data for QTIP, so I had to substitute that for TIP, the iShares ETF that tracks the same index.

Our Workshop portfolio is Portfolio 1…

And WealthSimple is Portfolio 2…

Now unfortunately, some of the ETFs in WealthSimple’s portfolio haven’t been around that long, so we can only do an apples-to-apples comparison back to 2016. So it’s not as much data as we’d like, but we can’t really do anything about that.

All in all, the two perform pretty much the same, generally tracking each other’s movements pretty closely.

Over the 2016-2019 period, the Workshop had a compound annual growth rate (CAGR) or 7.02%, while WealthSimple got 7.16%. That’s pretty much a statistical tie, so I’d be comfortable investing using either portfolio personally since they basically behave similarly. What’s interesting though is that both portfolios had about the same standard deviation, which is a measure of volatility. Workshop had a StdDev of 5.59%, while WealthSimple had a StdDev of 5.57%. Not sure that all that low-volatility stuff actually lowered volatility, but whatever.

So that’s the WealthSimple Canadian portfolio. Let’s hop across the border and see what the American one looks like…

USA

On the US, side our Workshop portfolio is even simpler, consisting of just 3 ETFs

And here’s WealthSimple’s portfolio.

So what do we see here? Similarly, on the fixed income side, we see that bonds have been split between LTPZ,MUB, and SPTL. LPTZ is a TIPS fund, and SPTL is a long federal bond fund, so similar bets on higher inflation and lower interest rates in the US for the near term. But instead of discount bonds, they use MUB, which is a municipal bond fund. Again, this appears to be an attempt to make the income more tax-efficient. For Americans, interest for municipal bonds, which are issued at the city or county level, are tax-exempt at the federal level. So that’s a good move there.

On the equity side, we again see two strategies emerge: an overweight on emerging markets and the use of more low-volatility ETFs.

So how do these two portfolios stack up? Again, we threw these two portfolios into Portfolio Visualizer’s Portfolio Backtesting tool.

Note: I had to make one substitution. Because IDEV is so new, if we use the WealthSimple portfolio as is we can only see two years of history. So I had to swap it out for a similar ETF IXUS, which is the iShares Core MSCI Total International Stock ETF that existed back in 2013. If we overlay IDEV and IXUS on a chart, we can see that the two funds track each other reasonably closely during the time period that they both existed.

So here’s the Workshop portfolio…

And here’s the WealthSimple portfolio…

When we overlay the two portfolios over each other from 2013 to 2019, we get this.

Again, the two portfolios perform mostly similar to each other.

In this case, the Workshop actually beat WealthSimple slightly over this time period, 6.97% to 6.5%, but when they’re this close we can call it basically a tie. However, it’s interesting to note that when we look at each portfolio’s volatility, WealthSimple’s StdDev is 7.02%, while the Workshop’s is 6.87%, meaning that somehow WealthSimple’s volatility is HIGHER, despite using low-volatility ETFs. If low-volatility ETFs don’t lower volatility, then what’s the bloody point?!?

Conclusion

So that’s our analysis of WealthSimple’s portfolio strategy. It’s based on the same principles that we base our portfolio on, and while they made some different decisions than we made when it came to ETF choices, the overall result is largely similar. I do question the value of adding in the low-vol ETFs, since they don’t seem to do anything, but other than that I think their portfolio is a perfectly fine choice to go and will generally get you where you need to go on your early retirement journey.

So with that being said, next week we will try out their funding options and see what happens when we perform our first buy! Read on to the next Workshop article!

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Disclaimer: The views expressed is provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions. The information contained in this blog was obtained from sources believe to be reliable, however, we cannot represent that it is accurate or complete.

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