Meet the New Funds, Same As the Old Funds

August 25, 2011

Vanguard Canada has yet to launch a single investment fund, but at least now we know what’s coming. On Tuesday, the company announced it had filed a preliminary prospectus for its first six ETFs.

When Vanguard first announced that it was coming to Canada in June, I wondered whether its arrival would really change the investing landscape. As much as I have enormous respect for Vanguard, I wasn’t sure whether another family of ETFs or advisor-sold index funds would offer Canadians anything they can’t already get. This new lineup of ETFs hasn’t done much to change my mind.

Let’s go through each of the six Vanguard ETFs and compare them to funds already available from iShares and other Canadian providers.

The Vanguard MSCI Canada will track an index of 100 Canadian stocks, so it falls right between the iShares S&P/TSX 60 (XIU), which has 60 large-cap holdings, and the iShares S&P/TSX Capped Composite (XIC), which has 260. (BMO and Horizons also offer large-cap Canadian equity ETFs.) The index—which is currently tracked by the iShares MSCI Canada (EWC) in the US—is not an improvement over the S&P benchmarks, so the new Vanguard ETF will have to compete on cost.

The Vanguard Canadian Aggregate Bond and the Vanguard Canadian Short-Term Bond will track indexes created by Barclays Capital. These are broad-based indexes that include both government and corporate bonds, and will likely be similar to those tracked by the iShares DEX Universe Bond (XBB), the BMO Aggregate Bond (ZAG), and the iShares DEX Short Term Bond (XSB). Again, unless these Vanguard funds have dramatically lower fees, they don’t seem to offer any meaningful advantage over what’s already available.

The Vanguard MSCI EAFE (CAD-hedged) will likely just hold Vanguard’s existing Europe-Pacific equity fund (VEA) with currency hedging and an extra fee. That would make it virtually identical to the iShares MSCI EAFE CAD-Hedged (XIN). There is some potential for undercutting iShares on cost here, though: XIN has a high management fee of 0.50%, while VEA charges just 0.12%.

The Vanguard MSCI Emerging Markets will not hedge currency, which means it will be a clone of the iShares MSCI Emerging Markets (XEM). It will likely just hold the US-listed Vanguard MSCI Emerging Markets (VWO) with an added fee. One would imagine it will be cheaper than XEM, which comes in at 0.79%. However, as long as you can trade in US dollars without excessive currency exchange costs, you can’t beat VWO and its 0.22% fee. (Remember that VWO, although it is traded in greenbacks, does not expose you to US dollar risk.)

That leaves only the Vanguard MSCI U.S. Broad Market (CAD-hedged), which will almost certainly be a Canadian wrapper for the Vanguard Total Stock Market (VTI), with currency hedging and the “Canadian discount” (an extra fee). This one will actually be unique. If you want to use currency hedging with your US holdings, then this ETF is a significant improvement over the incumbent iShares S&P 500 (XSP). That’s because the MSCI index includes more than 2,800 mid-cap and small-cap stocks that are absent from the S&P 500, offering broader diversification.

Six of one, a half-dozen of the other

So there you are. Of the six new ETFs in Vanguard’s initial lineup, only one promises to offer investors something they can’t already find on the TSX. Unless these new ETFs have much lower fees than their competitors—and these have not been announced yet—it’s hard to get too excited about them.

Frankly, I’m not sure how much Canadians can expect from Vanguard in the ETF department. They are highly unlikely to offer US and international equity ETFs without currency hedging, since Canadians can already buy their US-listed funds if that’s what they want. (At least, that has been iShares position since they added hedging to XSP and XIN in 2005.) And the fees on their ETFs will probably not be dramatically lower, because of the poor economies of scale in Canada. Other than XIU, with more than $10.5 billion in assets, not a single Canadian ETF has $2 billion under management, and only a handful have even $500 million. Compare that to the US, where Vanguard’s VTI, at $164 billion, has four times the assets of all Canadian ETFs combined.

What would make me take notice

In my view, the only way Vanguard will change the game in Canada is to launch a family of index mutual funds that charge 0.30% or less, and to make these available to DIY investors as well as through advisors. TD Canada Trust has made it clear they’re not interested in promoting their e-Series funds—indeed, it often seems like they bend over backwards to discourage you from getting them. So this is an area where Vanguard could dominate: if they offered cheap index mutual funds through discount brokerages, or through direct distribution, they could instantly render every one of their competitors obsolete.

They could also make a splash by offering passively managed, low-cost target-date funds. These one-stop solutions gradually adjust their asset allocation based on your time horizon, so you never need to worry about anything except regular savings. Vanguard offers both target retirement and target education funds in the US with fees under 0.20%. Can you imagine how easy being a Couch Potato would be with products like this? Unfortunately, the few that exist for DIY investors are actively managed and burdened with excessive fees.

Vanguard can certainly become a force for good in the Canadian investment marketplace. But that will happen only after they go beyond launching more redundant ETFs.

{ 20 comments… read them below or add one }

balk August 25, 2011 at 9:18 am

Would it be possible for a company to just interlist their ETFs like BMO, ENB, and BCE do?

Paul G August 25, 2011 at 10:04 am

Could you please clarify how the index for that first ETF isn’t as good as the one trracked by XIU ? My first thought was that a 100-company index might be more interesting (more diversified) than a 60-company one, so with comparable fees the new offering might be worthwhile.

Canadian Couch Potato August 25, 2011 at 10:16 am

@Paul G: I don’t mean to suggest there’s anything wrong with the MSCI Canada index, only that it’s not a significant improvement. It might be (marginally) more diversified than the S&P/TSX 60, but the Vanguard ETF is unlikely to be significantly cheaper than XIU. And XIC, in my opinion, is better than both of them, with much more exposure to mid-sized and small companies.

Charles Chase August 25, 2011 at 10:44 am

I was hoping for my own sake that they might cross-list ETFs, too.

I agree that the best result for Canadians would be for Vanguard to launch low-cost index mutual funds. It seems like they could do well by filling that big hole in out fund marketplace.

Mike Holman August 25, 2011 at 11:19 am

I’m not sure what you expected Vanguard to offer in terms of ETFs. Their bread and butter is broad-based index ETFs, so it makes sense that they would offer those here. Agreed, that they won’t add much to the investing landscape.

You’re right about the index funds – that’s the best way for most DIY Canadian investors to invest. I’d say that if Vanguard index fund fees are 0.5% (or less) and they offer some service – that would be a great set of products.

Canadian Couch Potato August 25, 2011 at 11:38 am

@Mike: In terms of ETFs, I wasn’t expecting anything other than what’s been announced, which was the original argument I made back in June. If Vanguard is going to bring anything genuinely useful to the party, it’s not going to be ETFs. We have too many of them already.

Canadian Couch Potato August 25, 2011 at 1:27 pm

I just got an email from Vanguard, who explained that they are not permitted to cross-list any of their ETFs in Canada. All of Vanguard’s ETFs are structured according to the Investment Company Act of 1940 (which governs mutual funds in the US) and cannot be listed on a foreign exchange.

The “ETF-like” securities that are cross-listed here and in the US are actually exchange-traded notes (ETNs), such as the iPath family, and unit investment trusts (UITs) such as the iShares Gold Trust (IGT).

Many thanks to Vanguard for clarifying this.

Sean August 25, 2011 at 1:51 pm

Personally, I would face a huge capital gains tax if I switched from XIU to their MSCI Canadian fund. This was the reason I didn’t buy XIC which you recommend in your Couch Potato portfolios. Maybe I will put “new money” in it over time if it does slightly better and has lower fees (MER).

Vanguard should have been here 10 years ago. Now I think they’ve missed the boat. There are just too many options.

Paul G August 25, 2011 at 2:58 pm

Sean: Unless Vanguard comes up with some compelling reasons to switch to their products (far lower costs, for example), I expect they have indeed missed the boat. The incumbents are well-entrenched.

CCP: I’d love to know how BMO’s ETFs are doing, overall (ie, have they been able to pick up enough traction in the makret to survive long-term, or will they all shut down in months or a few short years, as happened with another banks ETF offerings)

Canadian Couch Potato August 25, 2011 at 3:09 pm

@Paul G: BMO has done quite well with their ETFs — they passed $2 billion earlier this year. They have the benefit of a team of advisors who can sell them, which no other ETF provider can match. Vanguard has also said they will be working through the advisor channel, so I think they will do fine. It’s DIY investors who have little to gain.

Dan Hallett August 25, 2011 at 11:14 pm

Dan B – an excellent overview of the new & pending Vanguard ETFs!

Dan Hallett August 25, 2011 at 11:16 pm

It is worth noting that the $2 billion that BMO has amassed in its ETFs has come partly through its mutual funds, which in turn invest in ETFs. I thought that something close to half of its ETF assets were through the funds. But I might be a bit off on that figure. Still, $1 billion directly into the ETFs is nothing to sneeze at.

Cesar Acosta August 26, 2011 at 10:19 am

I honestly did not expect anything different from what they just announced and I am a little surprised you had an expectation (even if small…) they could have offered a different set of products. If they offer these products in Canada with a similar cost to those they offer in the US, that’s good enough for me as I don’t need any “fancy” new products that are hard to understand for the non-sophisticated investor like myself.
It would be great if you can write an article about the new Vanguard ETF’s as soon as they release their fees, basically stating Pros and Cons against similar products.
Keep up the good work!!!! Thanks for your valuable insights!!!

Cesar

Pacific August 26, 2011 at 12:14 pm

Another excelent review, thank you!
Hopefully Vanguard will take note and see the advantages of being more compeditive in our market.
Or, they could hire you to be their Canadian CEO!
:)

My Own Advisor August 26, 2011 at 3:01 pm

Excellent overview.

CanadianInvestor August 26, 2011 at 3:24 pm

I look at it like Walmart entering Canada. “Cheaper” has a big impact.

Canadian Couch Potato August 26, 2011 at 3:43 pm

@CanadianInvestor: Yes, but how much cheaper will these ETFs be? It is already easy to build an ETF portfolio for under 0.30%. Because of the economies of scale, it’s unlikely Vanguard or anyone else can bring that price down. BMO made no effort to so so when they launched their ETFs.

Wilcan August 28, 2011 at 8:32 am

If you see the introduction of these ETFs from the perspective of somebody who is about to start his/her DIY investment portfolio, maybe they would make more sense. It is clear that making the switch from currently existing options may not be the best option if fees are about the same or just slightly lower, but probably the picture looks different for somebody that is just entering the arena (just like me).

Jason August 28, 2011 at 10:52 am

Vanguard has ultra cheap ETFs listed in the US, but you state that, “it’s unlikely Vanguard or anyone else can bring that price down” (referring to MER of 0.3%). However, HXT from Horizon has an MER of 0.07%, so it must be possible. Could Vanguard offer these new ETFs in that price range?

BC_Doc August 28, 2011 at 11:04 pm

I’m just an individual investor, so my opinion is just one voice, however, I’d really like to see the following Vanguard products traded on the TSX:
1) a VTI equivalent– currency unhedged
2) a VEU equivalent– also currency unhedged
As an individual investor, I’ll be looking for an equivalent product which trades with a bid-ask spread equivalent to the US product version.
Thanks for the article!

Leave a Comment

Previous post:

Next post: