ETF Model Portfolios: For Performance and Comparison Purposes (EP.36)

Episode Summary

Executive Summary: The episode covers two major portfolio-design themes: rethinking asset location using after-tax, not pre-tax, asset allocation; and launching new ETF model portfolios that add U.S. small-cap and value tilts. The hosts also discuss the complexity of markets, the evolving value of advice, and why star managers and simplistic optimization stories often mislead investors.

Main Topics: Asset location should be judged on after-tax allocation (Priority: 5/5): The hosts argue that putting all bonds in an RRSP can make a portfolio appear 60/40 pre-tax while actually behaving closer to 75/25 after-tax, so the true risk level is higher than investors realize. Balanced asset mix across accounts as a robust default (Priority: 5/5): They defend their long-standing approach of holding a similar asset mix in all accounts because it avoids relying on uncertain future tax rates, yields, and income levels. New ETF model portfolios with factor tilts (Priority: 5/5): They unveil model portfolios that add U.S. small-cap value and U.S. value ETFs to capture size, value, and profitability-related expected return premiums without overcomplicating the lineup. Why factor tilts matter and where they work (Priority: 4/5): The discussion explains that many small-cap products include too much low-profitability 'junk,' so only certain index constructions, especially U.S. small-cap value, provide meaningful factor exposure. Market complexity and the limits of prediction (Priority: 4/5): Drawing on Team of Teams, they contrast complicated systems with complex adaptive systems like markets, emphasizing that investor behavior and competitive responses make forecasting unreliable. What advice firms actually deliver (Priority: 4/5): They review podcast insights on advisory value—organization, accountability, objectivity, proactivity, education, and partnership—and why execution, not just information, drives client outcomes. Industry evolution and the fading star-manager narrative (Priority: 3/5): They note that financial advice has repeatedly shifted as products and pricing commoditize, and use Bill Gross as an example of how hard it is to consistently generate alpha.

Key Arguments: Asset location decisions should be based on after-tax asset allocation, because that is what determines investor outcomes, not the pre-tax allocation shown on statements. Putting all bonds in an RRSP can unintentionally create a much more aggressive portfolio than the investor thinks they own. A balanced asset mix across all accounts is more robust because it does not depend on forecasting future tax rates, yields, or personal income. Many small-cap ETFs are not useful for factor investing because they include too much low-profitability stock, which dilutes or destroys the size premium. U.S. small-cap value ETFs can offer better factor exposure because some index methodologies also screen out weak businesses and inadvertently add profitability exposure. Adding small-cap and value tilts can improve long-run expected returns and even raise the worst observed 3-year return relative to a plain market-cap portfolio. The market and the advice industry are both increasingly complex and competitive, making simple narratives about prediction or manager skill unreliable. Advisory value is often less about picking investments and more about accountability, continuity, and helping clients execute good decisions over time.

Data Points: Episode number: 36 - They introduce the discussion as episode 36 of the Rational Reminder Podcast. Pre-tax portfolio example: 60/40 - Used for a $1 million portfolio with $400,000 RRSP and $600,000 taxable account. After-tax result when bonds are all in RRSP: ~75% equities - The hosts estimate that the pre-tax 60/40 portfolio becomes closer to 75/25 after tax. RRSP tax discount assumption: 53.53% or less - They note RRSP assets are worth less after tax depending on the marginal tax rate. Year-to-date small-cap value performance: ~17% - They say small-cap value has been on a tear so far this year. 6040 portfolio drawdown last year: 5 point something percent - Referenced to show recent market volatility and recovery. Rebound level: Back above January 2018 level - They note the 60/40 portfolio has recovered prior losses and more. Historical excess performance of new model portfolio: 36 bps annualized - Over 20 years, the new tilted portfolio outperformed a market-cap portfolio by 36 basis points annually. 10-year relative performance of new model portfolio: Trailing by about 30 bps - The tilted portfolio underperformed over the last decade, consistent with value headwinds. Lowest 3-year return comparison: 3% higher - The new model portfolio’s worst 3-year annualized return was 3% higher than the market-cap portfolio's. Russell inclusion universe: Bottom 2,000 of top 3,000 - They describe Russell’s mechanical method for selecting small-cap constituents. U.S. market concentration of advisory opportunity: ~7% of population - Michael Kitsis argues advisors compete for only a small slice of households with investable liquid assets. Potential advisory pricing model: 1% to 2% of income - Discussed as a possible service model for households with high income but limited liquid assets. Bill Gross fund asset decline: From roughly $2B to ~$900M - They mention the Janus bond fund shrinking after launch and retirement news.

Pivotal Quotes: "The only thing that matters to your returns is your after-tax asset allocation." — Benjamin Felix: Core argument in the asset-location discussion. "If something is measurable, it will become a commodity." — Michael Kitsis (quoted by hosts): Used to explain pricing pressure and evolution in the advice industry. "Strategy is easy, execution is hard." — Cameron Passmore: Explains why knowing the right approach does not guarantee investor behavior or outcomes.

Implications: Investors should think in after-tax terms, not just account-by-account optics, and should not assume bonds-in-RRSP is always optimal. The episode also reinforces that disciplined execution, broad diversification, and carefully chosen factor tilts matter more than star managers or prediction.