When constructing a well diversified exchange traded fund portfolio, it is important to maintain strong “core” allocations before diverging off the beaten path.
“Ideal strategic ‘core’ portfolios give broadly diversified exposure to an entire asset class,” according to Morningstar analyst Michael Rawson. “Highly correlated securities with similar risk and return characteristics are grouped together to eliminate idiosyncratic risks. Index inclusion rules should be liberal. The idea here is to hold the entire market.”
Rawson explains that the exposure should provide a type of “set and forget” mentality where they will provide stable returns over time. [Investing with ETFs: What You Should Know]
“Whereas active portfolio managers may ‘drift’ as they feel conditions warrant, a good “core” index fund, by definition, does not stray from its stated objective,” Rawson added. “Perhaps most importantly, the costs of a solid ‘core’ portfolio should be extremely low.”
Recently, iShares launched a suite of “Core” ETFs that try to provide the necessary core investment exposures, including U.S. stocks, international stocks and taxable bonds. Micro-caps are excluded, but the asset class makes up around 2% of the equity market. Bond funds exclude Treasury Inflation-Protected Securities, high-yield and international bonds as the funds reflect the construction of the widely viewed Barclays Aggregate Bond index.