Anatomy of a Portfolio Change – Core Equity Spotlight on SCHF

money on the brainAs part of our ongoing series of spotlighting one of our Investment Model preferred holdings, I would like to provide some color on the Schwab International Equity ETF (symbol: SCHF). SCHF is brand new to our Core Equity Model Portfolio so we thought it may be educational to our readers to go through the mechanics involved during a portfolio change to spotlight some of the behind-the-scenes processes.

Our main investment management goal: participating in “good” times and protecting in “bad” times. To put it in baseball terms, and I must do that as the Chicago Cubs are playing meaningful baseball still here in June, those that have worked with us know that we aren’t focused on hitting “home runs”; instead we are more interested in avoiding unnecessary risk and “hitting steady singles and doubles.”

How we seek to accomplish our goal:

  1. We have three main strategies: our Core Equity, Core Fixed Income, and Liquid Alternatives models.
  2. We use a combination of passive and active styles within our strategies. We generally use passive for our Traditional Core Equity and Fixed models, and use active for our Liquid Alternatives model.
  3. We generally only use relatively low-cost mutual funds and ETFs. (From last month’s blog, you learned that our Core Equity model had a weighted OER of 0.34% (now 0.32% after change described below), and our Core Fixed Model has a weighted OER of 0.37%.)

So, what’s our process? Here’s the short list in layman’s terms:

  1. Keep informed and educated. We stay abreast of the latest by reading a lot, attending conferences and trade shows, and networking with others both inside and outside of the financial industry.
  2. Constantly monitor the investment landscape for what’s new and knowing what’s already out there.
  3. Monitor and track current holdings. Adjust weights if needed.
  4. Analyze if anything out there is better than what we already have in place.
  5. Avoid unnecessary transactions and over-trading: transactions can be costly if not done correctly. Furthermore, it may lead to unnecessary tax ramifications.
  6. Understand where the market cycle is and never fall victim to trading based on emotion. I.e. buying the latest fad (buying high) or selling something temporarily out of fashion (selling low).
  7. Rebalance regularly to get your asset allocation percentages in-line with their target, thus, in concept, buying low and selling high.
  8. Trade efficiently. Strive for best execution. Every client is treated fairly when traded on a global basis.
  9. Ultimately, make thoughtful, wise changes where expected value is apparent. (No knee-jerk reactions).

Now, let’s look at that process in action. Last month, as part of our regular research, we came across a swap opportunity within our Core Equity strategy.

We found some advantages of holding the Schwab International Equity ETF (symbol: SCHF) over one of our then current Core Equity model holdings: the Dreyfus International Stock Index mutual fund (symbol: DIISX). Listed below are the major reasons why:

  • Similar coverage: both seek diversified international developed exposure, something we desire to hold for a minority allocation within this Core Equity strategy.
  • Lower Operating Expense Ratio (“OER”): SCHF has the lowest OER of any of its peers in this space at a ridiculously lean 0.08%.
  • No transaction fee: Typically, ETFs have a $8.95/trade transaction fee, but as part of Schwab’s relatively new ETF OneSource platform, SCHF can also be bought and sold with $0 transaction costs which is the same as DIISX, but…
  • Not subject to a Short-Term Redemption Fee (“STRF”): Mutual funds on Schwab’s OneSource platform generally need to be held for 90 days or are subject to a 2% STRF. STRFs were put in place to prevent “day trading” these funds which in many people’s eyes are meant for the long-term. However, ETFs are a different breed of animal in that they trade intra-day and the day trading issues are really not valid. As such, ETFs both on and off Schwab’s ETF OneSource platform are not subject to any STRF. Fabulous!

DIISX had been good at providing us with diversified international developed exposure while charging a modest 0.60% OER. But in this fast paced age, new products are increasingly becoming available. A lot of them are just a silly variation of something we already have, or something completely unnecessary. But every once in a while something decent comes out which may not be a perfect fit at first, and we keep it on our radar. In the case of SCHF, we needed to make sure that Schwab ETFs would develop a meaningful following and that this security would have appropriate liquidity (measured by its average trading volume) – those are both valid today. Furthermore, the success so far of the Schwab ETF OneSource platform, with its attractive characteristics listed above, made our decision to make a portfolio change an even easier one.

As always, please don’t hesitate to ask any questions about costs, trading, investment vehicles or anything else. And, go Cubs!