Years ago, when financial advisors had a monopoly on asset allocation decisions, fees ran rather rich. Lately, though, with a surge in the number of index-based products promising to deliver asset allocation on the cheap, costs are shrinking. That’s a boon for investors but, as always, leads us to wonder if they’re getting value for the money.

There are now 40 exchange traded products in the asset allocation category—most of which are young with short track records. If we screen for products with more than $50 million in assets and more than three-year history, we end up with half a dozen iShares funds worthy of examination.

BlackRock’s ETF suite includes both target-risk and target-date products so we can get a broad perspective on the category. Target-risk funds are geared for investor “types,” i.e., “aggressive,” “moderate,” and “conservative,” and tend to maintain static allocations to asset classes. Target-date products, on the other hand, follow a dynamic asset allocation model, gradually becoming more conservative, or bond-heavy, as the target date is approached.

Within the target-risk category is the iShares Aggressive Allocation ETF (NYSE Arca: AOA), which aims for long-term capital appreciation by maintaining a hefty exposure to equities. Like the other three funds in the iShares target-risk lineup, AOA is an ETF-of-ETFs. The portfolio’s largest allocation (30 percent) is the iShares Core S&P 500 ETF (NYSE Arca: IVV), representing large-cap domestic stocks. Developed foreign market equity exposure (21 percent), obtained through the iShares MSCI EAFE ETF (NYSE Arca: EFA), provides global balance. Domestic mid-cap and small-cap ETFs, together with an emerging market fund, make up another 30 percent of AOA, leaving 15 percent to fixed income products and 4 percent to real estate. AOA has an annual expense ratio of 30 basis points, but you could put this portfolio together yourself for 22 basis points. You’re paying 8 basis points a year for packaging.

A notch down in aggressiveness is the iShares Growth Allocation ETF (NYSE Arca: AOR) which, oddly enough, doesn’t hold any growth-tilted ETFs per se. Instead, AOR’s modestly aggressive stance is achieved through tweaks in the sizing of its component funds. Though AOR owns the same iShares ETFs as AOA (see Table 1), the allocations to large-cap foreign equity, small-cap domestic stocks and junk bonds are goosed up slightly. AOR’s annual expense ratio is 30 basis points. The “do-it-yourself” cost is 22 basis points.

The iShares Moderate Allocation ETF (NYSE Arca: AOM) achieves income generation, capital preservation and modest capital appreciation with a larger dollop of fixed income ETFs. Combined, the weight of AOM’s four bond ETFs tips the scale at 51 percent. Equities account for 47 percent of the portfolio and real estate just 2 percent. With an expense ratio at 31 basis points, and a “DIY” cost of 20, investors are paying 11 basis points a year for convenience.  

Real estate is completely absent in the iShares Conservative Allocation ETF (NYSE Arca: AOK), with primary objectives of current income and capital preservation. It has a 65 percent allocation to fixed income and a 35 percent exposure to equity. There is, however, a 12 basis point convenience charge. AOK’s annual expenses run 29 basis points, versus 17 basis points to replicate it yourself.  

Dynamic Asset Allocation

In the target-date sector, the biggest product is the iShares Target Date 2020 ETF (NYSE Arca: TZG). Over time, the fund’s rules-based methodology adjusts asset allocations for investors with a target retirement horizon around 2020. With retirement just six years away, TZG investors now find themselves with a 56 percent equity exposure, a 43 percent allotment to fixed income and a lowly 1 percent allocation to real estate. TZG’s convenience cost is 14 basis points.

Further out on the retirement horizon is the iShares Target Date 2040 ETF (NYSE Arca: TZV), which invests heavily in equities at 80 percent. A fifth of the fund is made up of fixed income funds, while less than 1 percent goes to real estate. Bundling costs 13 basis points.

Comparing the TZG and TZV allocations, you get a sense of the progression in a dynamic asset allocation. Assuming the portfolio mix in TZV “becomes” that of TZG over 20 years, fixed income exposure more than doubles.

Also noteworthy is the cost for all this. Target-date investors pay a slightly higher (3 basis points) convenience charge compared to that levied on target-risk investors. Is 0.03 percent too much to pay for ongoing portfolio tweaking?

Perhaps a better way to assess the cost of asset allocation is to compare these funds to a classic—and static—portfolio made up of 60 percent domestic equity and 40 percent broad-based bonds. Over the past five years, this model portfolio, with an annual cost of just 9 basis points, produced an average annual return of 15.9 percent and, with its relatively modest volatility, earned a 1.28 Sharpe ratio. None of the iShares funds outdo the model’s Sharpe ratio, but three crank out positive alpha. Alpha measures the risk-adjusted outperformance or underperformance of each fund against the model. (See Table 2.)

Among the target-risk funds, only AOK—the most conservative portfolio—earns positive alpha, but both target-date funds are alpha producers. To get even more granularity in the value-for-money proposition, divide each fund’s alpha by its convenience cost, or the premium paid for bundling the portfolio. Doing so, you can discern each fund’s real expense or benefit.

The bottom line? Look beyond simple returns to measure the value of asset allocation. There’s a cost for everything.