Vanguard’s New World Order

If you follow my model ETF portfolios, you may have noticed that one of your holdings has a new name.

The Vanguard FTSE All-World ex Canada (VXC), launched in the summer of 2014, is a simple, low-cost way to get exposure to stocks in the US as well developed and emerging markets overseas. Now VXC has evolved to cover even more of the global equity market, and further expansion is planned for the coming months. To reflect these changes, the fund recently changed its name to the Vanguard FTSE Global All Cap ex Canada Index ETF. The ticker symbol remains unchanged.

VXC is an “ETF of ETFs” with four underlying holdings: the Vanguard Large-Cap (VV), the Vanguard FTSE Europe (VGK), the Vanguard FTSE Pacific (VPL), and the Vanguard FTSE Emerging Markets (VWO). The latter three ETFs recently adopted new benchmark indexes that include small-cap stocks as well as large- and mid-caps. As a result, the total number of stocks held by VXC has swelled from just over 3,000 at the end of August to more than 5,100 today.

The addition of all those stocks makes VXC more diversified than ever, though the numbers are a bit deceiving. Since the 2,000-plus newly added stocks are all small companies, they don’t exert as much as influence as you might expect: small-caps now make up only about 6.5% of the fund by market cap, while those considered “small/medium” make up another 13%. Think of it like adding a bucket of pebbles to a pile of boulders. Sure, there are now many more objects, but the overall proportion haven’t changed very much.

More growth is on the horizon for VXC: its emerging markets index will gradually expand to add more and more China A-Shares. These are Chinese companies that trade on the Shanghai and Shenzhen exchanges and were previously off-limits to foreign investors. Those restrictions are now being relaxed, and in the coming months, emerging markets benchmarks will begin incorporating more A-Shares, giving China a larger share of index funds such as the VWO and, by extension, VXC.

One question remains unanswered: will Vanguard eventually replace the large-cap US equity fund in VXC with one that also holds mid- and small-cap stocks? Or perhaps add other US equity ETFs to cover those bases? With VXC’s new “all cap” mandate, this would make sense. However, replacing its current holding in VV with, say, the Vanguard Total Stock Market (VTI), would result in a sizable capital gain being passed along to VXC investors. That’s a good reason not to make the switch.

Arresting developments

The changes FTSE is making to their indexes will also affect the Vanguard FTSE Developed Markets (VEA), a US-listed ETF that remains popular with Canadians. Not so long ago, this ETF tracked the MSCI EAFE Index, the best-known benchmark for developed markets overseas. It later adopted a FTSE index that had a similar mix of countries in Europe and Asia, as well as Australia. Now the fund is changing indexes again: it will soon track the FTSE Developed All Cap ex US Index, which includes a roughly 7% allocation to Canada. If you’re a Canadian using VEA for your international equity holdings, that’s not ideal, since you’re already getting your Canadian exposure elsewhere.

But here’s a situation where the math reveals this is a trivial concern. Say you’ve allocated 20% of your portfolio to Canadian equities and another 20% to international. The additional Canadian content in VEA would change your mix to 21.4% Canadian and 18.6% international. That’s an insignificant difference—indeed, normal fluctuations in the stock markets and currency exchange rates can move you that far off target in any given day.

If you hold VEA in a non-registered account, selling it and realizing a capital gain isn’t worth it, but if your holdings is down in value, you could take this opportunity to do some tax-loss harvesting. If you hold it an RRSP, you might just wait until the next time you need to rebalance, when you’ll be making some trades anyway. A good replacement in both cases—assuming you want to continue using a US-listed fund—would be the iShares Core MSCI EAFE (IEFA).

Once VEA’s changes have been implemented, expect more rejigging at Vanguard Canada. The Vanguard FTSE Developed ex North America (VDU), as well as its currency-hedged counterpart, uses VEA as its underlying holding, so it will get a name change. Vanguard has also announced that in December it will launch a new ETF, the Vanguard FTSE Developed All Cap ex North America (VIU), as well as a currency hedged version with the ticker VI. These funds will presumably use VGK and VPL as their underlying holdings, thereby avoiding Canada.

 

26 Responses to Vanguard’s New World Order

  1. gsp October 26, 2015 at 8:59 am #

    Did you revisit the US equity question with VG? Their answer as to future plans last time was clear as mud.

    Is the new index available to be consulted anywhere? A FWF poster has speculated that adding VB to the current holdings would seem to approximate the number of holdings of a similar(but not Canada specific) FTSE Global all cap index.

    As if lower cost and better tax efficiency weren’t enough, XAW provides a clear list of its constituent ETFs and their weightings as well as their underlying holdings.

  2. Canadian Couch Potato October 26, 2015 at 9:25 am #

    @gsp: ETF providers never tip their hand about whether they will add or delete a specific underlying holding. They are obliged to announce index changes, but Vanguard isn’t going to publicly say they are thinking about adding VB, or anything that specific.

    It’s true that XAW has a slightly more tax-efficient structure if held in an RRSP or TFSA:
    http://www.canadianportfoliomanagerblog.com/war-of-the-worlds-ex-canada/

  3. KISS October 26, 2015 at 11:00 am #

    On the issue of bringing US small caps into VXC:

    1. It doesn’t make a lot of sense to name your ETF after an index (in this case, FTSE Global All Cap) and then not include in the ETF small caps from the largest component country, i.e., from the US.

    2. Failing to bring US small caps into VXC means VXC will systematically fail to track its index. Seems perverse to construct an ETF in a manner so as to guarantee tracking error.

    I have to believe Vanguard is addressing this issue.

    I own VDU in a TFSA. Its gaining Canadian content is an irritant. I’ll wait for the new VIU before deciding whether to switch to VIU or to XEF.

  4. osman3500 October 26, 2015 at 12:36 pm #

    I don’t see the point in having VXC when XAW is both cheaper and more tax efficient. I would rather want VXC to compete on these points.

  5. Jim October 26, 2015 at 12:52 pm #

    Thanks for the updates on these ETFs. This is the place to come to get easy access to the latest ETF info for Canadians!

    I have a question re: Diversification Vs. Costs.

    VXC is more diversified than VFV, but it is triple the cost. .25% Vs. .08%

    But VFV – the companies of the S&P 500 – do get something like half of their business from the world and 50% from the US. So it is diversified in that respect.

    You recently covered Meb Faber’s latest book in Moneysense – and his conclusion was that costs are the most important factor in a portfolio.

    Given that VFV is quite diversified, but not as diversified as VXC, but VFV is 1/3 of the cost of VXC, what are your thoughts on just using VFV instead of VXC for exposure to non-Canadian stocks?

    I did a quick calculation, and on a $1,000,000 sum in the ETF, growing at 3% per year, the total difference in fees (between VXC – VFV = .17%) over the 30 year period would be more than $80,000.

    That seems like a lot of money. Is the extra diversification of VXC worth it?

  6. Canadian Couch Potato October 26, 2015 at 1:02 pm #

    @Jim: Using VFV (or a comparable fund) in place of VXC is ignoring half of the world’s capital markets. VFV is well diversified in terms of economic sectors, but it still has all of its equity and currency exposure in one country. It’s true that many large US companies do much of their business overseas, but that does not give their stock prices a high correlation with international markets. At the end of the day, most US stocks behave like US stocks.

    Holding both US and international equities should lower the volatility of a portfolio and give you the opportunity for a “rebalancing bonus.” It’s also less risky than holding almost all your equities in a single country and currency. In my opinion that is worth more than 0.17% annually.

  7. Roger October 26, 2015 at 2:49 pm #

    While it certainly seems convenient one of the things I have learnt to ask thanks to this site is how good is the tax efficiency of this “ETF of ETFs” structure? Since VXC holds the US-listed VGK ETF which then holds European stocks will it not be the case that you end up paying any European withholding taxes on dividends, followed by US withholding (due to VGK)?

    If the above reasoning is right it would mean that you might get compounded foreign withholding taxes without any chance to claim them back if VXC is held in registered account. So wouldn’t you be better either purchasing the underlying US-listed ETFs directly or even better purchasing Canadian listed ETFs which hold some or all of the non-US foreign stocks directly?

  8. Canadian Couch Potato October 26, 2015 at 2:59 pm #

    @Roger: These are all good points I have written about extensively on this site. The short answer is yes, the “ETF of ETF” structure is generally less tax-efficient than holding US-listed ETFs directly in an RRSP. However, this needs to be weighed against the cost of converting CAD to USD to buy US-listed ETFs:
    http://canadiancouchpotato.com/2010/01/24/should-you-buy-us-listed-etfs/

    Canadian ETFs that hold international stocks directly are indeed more tax-efficient and are a great choice if you are splitting your foreign holdings across multiple funds rather than using a one-fund solution like VXC.

    Bottom line, it’s about trade-offs, and each investor needs to decide how much complexity they want to introduce in order to keep costs and taxes as low as possible.

  9. Dimitris October 26, 2015 at 5:48 pm #

    Hi Dan,

    I was wondering where you actually get the information about which US ETFs this ETF invests in. Vanguard lists the individual stocks in their site and prospectus for the ETF. It does state that all it does is hold the US-listed ETFs but doesn’t list which or at which percentage.

  10. Doug Cronk October 26, 2015 at 7:19 pm #

    Hi, Dan.
    I have to say ‘no Thanks, Vanguard’. VXC with VPL imbedded has 60% Japan exposure.
    I much prefer the more diversified (23% Japan) and less expensive VEA.

  11. Canadian Couch Potato October 26, 2015 at 9:41 pm #

    @Dimitris: Good question: I do wish Vanguard would put this information directly on its website. Unfortunately you have to get it from the Management Report of Fund Performance, which is sent to unitholders twice a year and is also available from the SEDAR website.

    As of June 30, the proportions were roughly 52% Vanguard Large-Cap, 23% Vanguard FTSE Europe, 15% Vanguard FTSE Pacific ETF, and 10% Vanguard FTSE Emerging Markets.

    @Doug: I don’t think that’s a fair comparison. VEA holds both European and Pacific stocks, while VPL tracks only the latter, so its allocation to Japan must be higher. Holding VEA is roughly equivalent to holding two-thirds VGK (Europe) and one-third VPL (Pacific). Instead of holding 23% VGK and 15% VPL, VXC could have just held 38% VEA and the diversification would have been roughly the same as they are now.

  12. Dimitris October 27, 2015 at 8:51 am #

    Thanks Dan,

    I think BlackRock is way better at making it more visible which US-listed ETFs their Canadian ETFs own. You can’t have everything I guess.

  13. Joshua October 27, 2015 at 3:07 pm #

    Hi Dan,
    If I am the laziest of investors, and want to replace the vcn/vxc combination with a single fund — is there such an option that doesn’t greatly increase MER?
    Assuming I have done my research, and am happy with a <5% C$ and CDN equity exposure, and just want to buy the world (in both registered and non-registered accounts).

  14. Canadian Couch Potato October 27, 2015 at 3:20 pm #

    @Joshua: One option would be the iShares MSCI World (XWD):
    https://www.blackrock.com/ca/individual/en/products/239697/ishares-msci-world-index-etf

    Note that XWD (unlike VXC) does not include emerging markets. There are a few US-listed options for all-world ETFs, but I would not recommend them unless you have a reliable way of converting currency at low cost.

  15. Ryan October 27, 2015 at 4:52 pm #

    Do you think Vangaurd Canada will ever offer brokerage accounts like they do in the US?

  16. Julien October 27, 2015 at 7:50 pm #

    Talking of VXC, anybody here using questrade noticed a litle icon (white round shape with an ”i” inside of it) saying that this security cannot be quoted or traded? .. I notice that since they changed the name of the ETF. Contacting Questrade, they said it my be my cookies causing problem. I deleted them .. and it stills show the message. The only way to buy the ETF for me is to send it to level 1 and click buy from there.. Anybody in the same situation?

    Thanks!

  17. Canadian Couch Potato October 27, 2015 at 11:55 pm #

    @Ryan: I can’t say for sure, but I highly doubt it. I don’t think it’s a particularly profitable business.

  18. gil October 28, 2015 at 10:28 am #

    I’m using XWD because it’s not currency hedge.

    It’s up 16.57% YTD as of October 27, 2015.

    Source Globe Investor.

  19. Richard November 6, 2015 at 9:25 am #

    With the regular changes vanguard has, it seems that if you buy an ETF you don’t know what you’ll be holding in 5 years. Not quite passive.

    They seem to be deviating from the idea that it’s better to get something good enough and leave it alone than to constantly make changes seeking minor improvements, and they’re making changes in a way that forces them on current investors instead of giving them a choice.

    Never thought I would say this but I would start avoiding vanguard except for investors who want to monitor their portfolio very frequently.

    I know Bogle has disagreed with the current management on a few things for some time. Vanguard does not necessarily reflect his vision anymore.

  20. Brian G November 10, 2015 at 12:49 am #

    @Richard, I agree 100% with you. I’ve given up on Vanguard Canada. First the MSCI to FTSE changes and now this. They also had a high bid-ask spread for a long time compared to their competition.

    I’ve found Blackrock/iShares to be much more predictable. When they introduce/acquire new products, they leave the existing ones alone and leave it up to investors to choose whether they want to switch to new products or not. I’ve also grown to like some of the BMO ETFs and they’ve stayed consistent as well. I’m glad there is competition.

  21. tytw00 December 16, 2015 at 10:59 am #

    Hi, I follow the old model portfolio of using VUN and XEF for Us and International exposure. Given that the MER’s for both VUN and XEF are lower than VXC, would it just make sense to keep VUN and XEF in my portfolio. I take it the additional cost will be to rebalance every year (but that only costs me one additional trade since I rebalance by buying new units). I have over $40,000 combined for VUN and XEF. Thanks.

  22. Canadian Couch Potato December 16, 2015 at 11:11 am #

    @tytw00: I would not be in a hurry to switch to VXC if you already own VUN/XEF. The one thing to consider, however, is that VXC also includes emerging markets, so you would need to add a third fund (such as XEC) to more closely match the exposure you’d get from VXC.

  23. Kris January 8, 2016 at 3:01 pm #

    Happy New Year – I know you can’t give specific advice – my portfolio is curently based on one of your “older” modela (ZRE; XRB; XIC; VAB; VT:US)

    and I really like the even-simpler Option#3 with 3 Vanguard funds. It’s time for my yearly re-balance; does it make sensé to rebalance to the 3 Vanguard funds?

    Thanks as always for your informative site.

  24. Canadian Couch Potato January 10, 2016 at 5:28 pm #

    @Kris: If your goal is to rebalance AND simplify your portfolio, then it may indeed make sense to move to the newer model to strip away the optional asset classes (real return bonds and REITs) and to get away from US-listed ETFs.

    However, if the US-listed ETF is in an RRSP, it might be worth sticking with it, because US-listed ETFs are significantly more tax-efficient in RRSPs (but not in other account types).

    Moreover, there is no reason to prefer VCN over XIC: both are perfectly good choices.

  25. Baba March 17, 2016 at 10:35 pm #

    Hi Dan,
    I love reading Canadian Couch Potato.
    I have a question for you: I have $50,000 to invest in non-registered portfolio. I have never invested in ETFs so far and I am seriously thinking (and as I am close to 50 now), in investing in ETFs. Most of my stocks are in Canadian market. The question is if I need to invest in diversified market, what would you suggest? I am in it for long term.( for US and Emerging market – I was thinking about VUN and VWO. Thank you for your opinion.

  26. gsp June 17, 2016 at 4:49 pm #

    5 months after this post they still had not added US small caps as pointed out by Justin here. http://www.canadianportfoliomanagerblog.com/perfecting-the-perfect-portfolio/

    In a few weeks the next quarterly portfolio disclosure will be issued and holders of VXC will hope Vanguard has finally decided to follow their own new benchmark. What a terrible way to have to invest, not knowing what you’re buying. Ishares and XAW, the clear superior option.

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