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Lars Kroijer on…hedge fund mimicking ETFs, checking your portfolio, and minimal risk assets

When we asked you for questions to put to passive investing guru Lars Kroijer, we were inundated. So we’re doing something a bit different – a collaboration between Monevator and Lars’ popular YouTube channel.

Every month Lars will pick a few of your questions and then answer them individually, in video and transcript form, as below. We’ve already got enough questions to last us a year or two, so sit back and enjoy!

Note: embedded videos are not always displayed by email browsers. If you’re a subscriber over email and you can’t see the three videos below, head to the Monevator website to view this Q&A with Lars Kroijer.

Should I invest in passive products that mimic hedge funds?

First up this time, Tony asks about ETFs that seek to mimic hedge fund exposure. Do they make sense for a passive investor?

Lars replies:

In short, I don’t think you should invest in these sorts of products. There are a couple of reasons.

First of all, it’s incredibly hard to mimic hedge fund exposure. There are perhaps 10,000 hedge funds in existence. They are doing all sorts of things. But it’s really really hard to get access to a lot of them – they’re closed for new investments. Besides, it would be impossible to create investments in the proportions or the sizes of these hedge funds.

So the exposure you’ll end up having is probably quite far from the actual hedge funds’ exposure.

I think what a lot of these ETF providers try to do is not to replicate an investment in hedge funds, but to say synthetically what does hedge fund exposure look like? So they would say that hedge fund exposure is like having point two of S&P, point one of oil, point two of gold, and so on. But like this you’re creating a lot of tracking error versus the actual hedge fund industry.

To me, a passive investor is someone who doesn’t think that through active security selection they can outperform the market. I think there are a lot of benefits from coming to that realization. But a hedge fund is almost opposite of that. And by picking the people that we think can outperform the market – the hedge fund managers – we are indirectly being the pickers ourselves, too, by picking the funds.

So I think investing in hedge funds is almost the opposite of what a passive investor should do. Generally, the huge fees and expenses associated with the funds put you so far behind that unless you have some special angle, it’s worth staying away from them.

There’s probably been some value created in hedge funds over the last couple decades, but there’s also been tons and tons of fees. There’s also selection bias – we tend to hear from only the successful funds, much like in the mutual fund industry, and we don’t hear about the huge failures because they tend to die and disappear. That’s another reason I think just to stay away from this type of investment.

I would say that if you’re really interested in hedge funds (and if you’re able to invest in them, because they often have minimum investment sizes) I would do the work and find a few funds that perhaps offer unique investment opportunities, and invest in those.

That can be an incredibly exciting thing to do and but it’s also something that’s hard for regular investors. In any case, I think it is slightly outside the scope of this question.

Checking up on your portfolio

Rick asks how often he should monitor the funds in his portfolio:

Lars replies:

First of all, there’s no firm rule for this whatsoever.

Just to take a step back, one of the major benefits of a passive portfolio – on top of probably making you wealthier in the long run – is that you spend very little time on it.

You don’t have to spend a ton of time reading the Financial Times, the Wall Street Journal, or research reports. You don’t have to understand whether Facebook is a better investment than Apple. No, you just buy the broadest cheapest index tracker and let the market do all that for you. That saves you a ton of time.

Incidentally, let’s say you invest in a market that’s up 10% – say Europe. [With a tracker] you make that investment with zero time spent and almost no cost.

Let’s say instead you’re up 12% [from investing actively] in the market. That’s only 2% that you spent all that time to achieve – because 10% you got via the market!

I’d even question whether you can reliably make 2%. But even if you did, it’s only the 2% extra you spent all that time achieving.

Coming back to the question, I would say definitely have a look at your portfolio when there’s money flowing in and out. Also have a look when something in your personal circumstances has changed that could impact your risk profile.

This could be a personal thing such as – to start with the positive – a bonus at work. Or it could be you lost your job. Perhaps you got a windfall through an inheritance, which is often obviously not entirely a good thing. Or perhaps there’s an external issue, such as an economic crisis where you live.

I would definitely have a look in those circumstances – and perhaps it’s not a bad idea to get help from a local financial adviser.

But in general, I’d say have a look at it every three to four months just to make sure things are not totally out of whack and then have a more thorough review once a year, perhaps again with a financial adviser. In general, when you hear lots of financial drama in the news that could impact both the markets and currencies again, check out how that impacts your portfolio.

And of course as Rick suggests, once in a while you should think about whether there are better products out there? Has your tax situation changed?

And again, that could be worth talking to an adviser about.

What is the point of owning the minimum risk asset?

Finally for this session, Paul asks why do we need to have a minimal risk asset – that is, the lowest-risk asset we can get our hands on – in our portfolios?

Lars replies:

The short answer is you don’t always need this asset, but you’re very likely to.

Just taking a step back, it’s my view that most people are very unlikely to be able to outperform the financial markets. As a result, they should put together a very robust two product portfolio.

Firstly, they should invest in the global equity markets, through an index tracker typically.

Second, they invest in the lowest risk asset they can possibly get their hands on. For most people, this is typically government bonds that are highly rated in your local currency, with a maturity that suits your investment horizons.

You combine these two to match your investment risk profile, and you’re done! Investing can be more complex than that, but in my view, it doesn’t really have to be for most people.

So why do you need this minimum risk asset? Well, if your risk profile is such that the risk of the global equity market suits you, then you don’t need it. For most people though, that’s just too risky. So they temper the risk of the global equity markets by also investing in a very low-risk asset and then combining the two so that they optimize for their own risk.

Let’s say you want a 50/50 allocation – you’d need to put 50% of your portfolio in the minimal risk asset.

In some people’s cases, they want all their assets to have no risk at all! In that case they’d invest only in the minimal risk asset.

Until next time

Right, we’re out for this month. Please do feel free to add to or follow-up Lars’ answers in the comments below.

Watch more videos in this series. You can also check out Lars’ previous Monevator pieces and his book, Investing Demystified.

{ 30 comments… add one }
  • 1 Berkshire Pat November 5, 2019, 4:20 pm

    “the lowest risk asset they can possibly get their hands on….. government bonds that are highly rated in your local currency, with a maturity that suits your investment horizons”
    Does that mean buy Gilts and hold to maturity? What is an investor’s ‘investment horizon’ – when they are going to stop adding and start withdrawing? If I’m retiring in 2025 should I be buying Gilts that mature in 2025, both now and as I re-balance over the next five years?

  • 2 Matthew November 5, 2019, 5:41 pm

    Most pre-retirement savers will have mortgages, that would be the safest option investment, a debt in your own name – you could have an offset mortgage to make it accessable, but that comes with generally higher interest rates – I would just hold cash savings at the same rate as the mortgage to achieve the same thing more cheaply

    I think there’s too much devil in the detail for quality bonds, too much like hard work, dubious reward

  • 3 Mr Optimistic November 5, 2019, 5:48 pm

    The logic is to do with risk profile as I understand it. If this is going to ramp down towards retirement then you are in the logic of target retirement date funds. These reduce the risk profile until it gets to the level thought appropriate for a retiree. The portfolio at retirement isn’t targeted at zero risk. So if you think a longer duration bond fund is suitable now, but you want to reduce the duration as you approach retirement until it matches the retirement portfolio, then you are going to have to manage that. If you reckon an intermediate duration fund us appropriate now and in retirement then no change is necessary. Just find a fund with duration 5-7 years say and bobs your uncle.
    To buy a direct holding in a bond which matures at your retirement date only makes sense if you are going to take the cash out, otherwise you ae going to have to reinvest.
    At least that’s my thinking………

  • 4 xxd09 November 6, 2019, 9:56 am

    I invested initially in a Gilt “ ladder” pre retirement” using 5 year duration Gilts.Divided my Bond portion of my Portfolio into 5 sections .Took a while to set up and the just kept rolling them over as they matured.Seemed to work OK . I got tired of doing it and put all the Gilts as they matured into the Vanguard Global Bond Index Fund hedged to the Pound
    Gave me the benefit of American exposure (higher interest rates) and was simple,cheap and easy to follow

  • 5 Gentleman's Family Finances November 6, 2019, 11:00 am

    In the same way that most people think that they are a better than average driver – most people probably overestimate their stock (or hedge) picking abilities.
    I’ve heard people talk authoritatively about things that they could not possibly fully understand in the stock market and claim genius when it goes right and bad luck when it goes wrong.
    Another factor at play is that we tend to not leave things alone. By buying/selling, chopping and changing and making investment decisions – we give ourselves (private investors) the illusion of control over our finances. But often we buy high, sell low and waste a lot of time and effort doing so.
    For the best return on your investments, it’s maybe just a case of:
    1) find a low-price platform that suits you (i.e. don’t use SJP)
    2) buy low cost ETF trackers (preferably in tax advantaged accounts likes ISAs)
    3) hold and if you buy, set-up regular investments
    4) spend your time doing something else more enjoyable
    It’s boring but better than anything else I can think of.

  • 6 Berkshire Pat November 6, 2019, 11:39 am

    looks interesting, but probably not ‘minimal risk’ (hence >1% return, av YTM 1.3 %, duration >7)

  • 7 xxd09 November 6, 2019, 12:18 pm

    GFF re your point 4
    Jonathan Clements -a reputable financial blogger at “Humble Dollar” maintains that half your Portfolio growth comes from your Savings that you add to it
    All the more reason to concentrate on your day job where you have some measure of control and can make money and leave your Portfolio alone to grow under its own steam

  • 8 Gentleman's Family Finances November 6, 2019, 1:03 pm

    xxd09 – I absolutely agree.
    I think that many private investors get sucked into talking about investing/finance/”the markets” in the same way we can all become armchair football critics.
    More seriously, a feeling that I have is that there are lots of people out there looking to take your money – high fees, bloated trading costs and of course “75% of people lost money with CFDs with this provider”
    When investing starts to feel and look like gambling, then it’s time to just get back to basics: work, earn, save, invest.

  • 9 Gizzard November 6, 2019, 2:24 pm

    I have just noticed that the Vanguard Global Bond Index Fund hedged to the Pound fund which you referred to is now available in ETF format (VAGS). It’s cheaper (much cheaper if you have a larger portfolio) to hold (on Hargreaves Lansdown at least) than the fund version.

  • 10 The Rhino November 6, 2019, 2:37 pm

    I understand you have plenty of questions already but perhaps I could add one more to the pile?

    ‘How does the Lars passive portfolio look different in the decumulation phase than the accumulation phase (if at all)?’

    I believe the second edition of your book should be arriving on my doorstep today along with McClung and Okusanya. Some autumnal reading to keep me out of mischief!

  • 11 Gizzard November 6, 2019, 2:39 pm

    The Rhino
    The McClung book is excellent. I didn’t rate the Okusanya one to be honest.

  • 12 Mr Optimistic November 6, 2019, 4:14 pm

    @Gizzard. I didn’t rate either book. Okusanya was too simplistic. McClung shows a typical US data nerd approach, the more numbers the better – all those tables ! TA says you can’t glibby follow the herd and assume a swr of 4%. His conclusion was ##%: clearly different. If you go through all of McClung’s feshistic calculations think the answer for a UK resident with current CAPE levels is around 3%. The real answer is no one knows.

  • 13 Gizzard November 6, 2019, 5:47 pm

    @Mr Optimistic I agree that no one knows the safe withdrawal rate. However, I seem to recall that McClung came up with a SWR higher than 4% (more like 5% or 6%) if you’re willing to take some risk that your safe withdrawal rate may not be 100% safe. I personally enjoyed all the tables and graphs (nerd). I can only admire the amount of work that went into it.

  • 14 Mr Optimistic November 6, 2019, 6:04 pm

    @Gizzard. Been a while since I read it but that seems high. The basic idea that you can and should find a maximum safe withdrawal rate and then apply this through the future according to a preset algorithm just seems a mad idea to me. Ok for an initial rule of thumb to spec the landscape but no more. Various other sources reckon sub 3% for the UK. Think that was Morningstar. All for a given probability of ruin, for which see

    (Dirk Cotton hates the idea of a mechanistic swr approach.)

  • 15 xxd09 November 6, 2019, 7:59 pm

    ETF version of Vanguard Global Bond only recently available
    12 Basis points for the ETF-I think -as opposed to 19 for the Fund
    Just gone from ATS to Interactive Investor -cheap for larger portfolios
    So will hang fire for a bit before doing anything
    Thanks for the info

  • 16 The Borderer November 7, 2019, 12:04 am

    Good point about VAGS. Also, no fund charges from AJB or II.

  • 17 Berkshire Pat November 7, 2019, 10:01 am

    Not entirely sure VAGS fulfills the role of minimum risk asset within the portfolio recommended by Mr Kroijer
    Vanguard place it as Risk Level 3 (range Low 1 to High 7) in the KIID

  • 18 Brod November 7, 2019, 10:12 am

    VAGS – Yeah, seems to be slug of Corp Bonds in there.

  • 19 Berkshire Pat November 7, 2019, 10:51 am

    All sorts in there. 17% is rated BBB. About 20% corporate.
    9.4% is “Securitized mortgage backed security pass-through” – no idea what this is…

  • 20 Grumpy Old Paul November 7, 2019, 12:54 pm

    Another simple cheap passive option is to use Vanguard Life Strategy 20 and reduce other pure equity holdings to achieve required portfolio asset allocation balance. Or split bond holding between VLS20 and Vanguard Global Bond Index Fund hedged to the Pound. VIGBBD has much lower volatility than VLS20 if memory serves me correctly. VLS20 has big slugs of government bonds.

    My platform is Iweb and I use funds in preference to ETFs where possible. ZXSpectrum can probably give us an informed opinion on the pros and cons of holding bond ETFs.

  • 21 xxd09 November 7, 2019, 4:42 pm

    Pat-take your point but look at the Vanguard risk assessment of UK Gilt Funds-even more risky-according to them
    Do they know something we don’t!?

  • 22 Mr Optimistic November 7, 2019, 4:54 pm

    Corporate bonds and asset backed stuff, along with government agencies etc are usual in these aggregate bond funds. If you just want sovereign then you have to specifically pick a gilt or treasury fund or such like. Some funds have chunks of high yield, sub- BBB and emerging market debt so it could be worse.
    Incidentally, Monevator did a piece on index linked gilts an age ago which pointed out their surprisingly high risk score ( owing, I think, to duration).

  • 23 SemiPassive November 7, 2019, 6:11 pm

    My take on time horizon comes from the point of view that I will be buying and holding decent yielding investments forever. But will probably want to use my 25% Tax Free Pension Lump Sum to pay off what is left of my mortgage at 55 or so.
    So by 55 I would aim to have roughly a quarter of my pension pot in minimal/low risk bonds – perhaps even matching maturity to that specific year – so there will be no danger of selling at a loss on that portion should the markets dip.
    As things stand mortgage rates are typically higher than the yield on such minimal risk assets so, it seems like the best risk free return you can get.

    As The Details Man pointed out in the recent article on annual allowances, the MPAA does not trigger when an individual takes a pension commencement lump sum only (and nothing else). So that gives you the option of carrying on making further pension contributions past 55 with the money saved from no longer having to make mortgage payments.
    Be keen to know if anyone else is planning a similar approach.

  • 24 Tim November 8, 2019, 1:58 am

    @xxd09 The Vanguard UK gilts index funds have risk scores of 4, 5 & 5 (for the U.K. Government Bond Index Fund, U.K. Inflation-Linked Gilt Index Fund & U.K. Long Duration Gilt Index Fund respectively) not because Vanguard “know something we don’t know” about the solvency of the UK government, but because those funds really are actually quite volatile (in fact the latter two are even more volatile than the FTSE100 according to trustnet’s “FE risk score” for them). They’re volatile because they’re long duration: 14, 23 & 21 years respectively. That massively magnifies the impact of any change in market sentiment about which way interest rates are going next.

  • 25 xxd09 November 8, 2019, 10:03 am

    Thanks for that-they are certainly longer duration bond funds than I realised
    I always wanted a Index Bond fund to save me the hassle of a 5 year gilt fund ladder-5 years being my ideal duration
    The Global Bond Index Fund hedged to the pound fitted the bill with average 7 years duration though it does have some corporate bonds which I could have done without
    A plus was the US exposure
    An inadvertent good choice!

  • 26 Berkshire Pat November 8, 2019, 2:56 pm

    I do feel that the ‘non equities’ part of passive portfolios is not covered enough – odd, as it will dominate most investors’ portfolios eventually. Not a criticism of this site, just a general comment.

  • 27 SemiPassive November 8, 2019, 5:35 pm

    xxdo9, iShares have a 0-5 year Gilt Index ETF, ticker is IGLS. Weighted Average YTM is currently 0.55% and the risk score is only a 2 (standard deviation is 1.09% so much less volatile than their IGLT etf).

  • 28 XC60 November 9, 2019, 8:55 am

    I have found articles , books by Lars etc as very helpful since starting a SIPP.
    But frustrating that no examples of low cost passive trackers every given – I have some funds in Vanguard LifeStrategy 40 – does that ‘count’- what are other examples as I want to reduce costs and reduce IFA fee and would like low maintenance funds.

  • 29 The Investor November 9, 2019, 9:33 am

    @XC60 — Fear not, that’s where we step in! 🙂 The following list of low cost trackers was good as of February this year. There may have been a few small changes since then:


    Here’s an evaluation of the all-in-one options (such as Vanguard Lifestrategy, which is indeed a solid choice for many people):


  • 30 The Rhino November 12, 2019, 1:34 pm

    Currently on a reading binge.

    Bit of a range.

    John Edwards (DIY Income, DIY Introduction…)
    Kroijer (2nd Ed)
    Mcclung (ongoing)

    Few things that struck me.

    One is for the Monevator book, you really want to lift it up above the ‘amazon home published’ look-and-feel if at all possible. In this respect I’d say Okusanya is borderline, Edwards is below, Kroijer is about where you want to be (which is similar to Hale).

    When I say look-and-feel obviously the writings got to be high-quality, but you also want professional typesetting, consistent formatting, high quality imagery that sort of stuff. Its critically important.

    I did enjoy the Edwards stuff though, it was readable and you have to balance against two books only costing me a tenner, but really only a couple of pages on how to pick ITs were what I found valuable and I could have done with more detail there.

    Okusanya was a bit too chatty, anecdotal, disorganised, most of the charts unreadably cluttered and low resolution. He needs an editor (or perhaps a better editor) and a better typesetter. But its opened my eyes a bit to the new-world-order of withdrawal strategies which by the look of it McClung is going to dial up to 11.

    Kroijer is really good, and 2nd ed is better than 1st. But its not about decumulation or income.

    But I think you can bolt Okusanya/McClung on to a Kroijer/Hale portfolio to get that..

    Really looking forward to the Monevator publication, will there be PR launch, signing etc.??

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