Archive | ETFs

Tax Tips for BMO ETF Investors

Last week I offered some tips for investors who are tracking their adjusted cost base with Vanguard ETFs. In this post I’ll offer similar advice for those who use BMO exchange-traded funds. These tips expand on As Easy as ACB, a paper co-authored with Justin Bender, which thoroughly explains how to calculate the adjusted cost base of your ETF holdings.

The BMO Equal Weight REITs (ZRE), which is the real estate component the Complete Couch Potato portfolio, provides our first example. You can start by downloading the BMO ETF 2013 Tax Parameters, which gives a summary of all distributions for the year. Scan the list until you find ZRE.

Notice ZRE reported both return of capital (ROC) and capital gains in 2013. ROC is normally paid in cash, and although it appears in Box 42 of your T3 slip, it’s not taxable in the year it’s received. However, it lowers your adjusted cost base and therefore increases your future tax liability.

Capital gains are taxable in the current year (they’ll appear in Box 21).

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A Tax Tip for Vanguard ETF Investors

As the tax filing deadline approaches, many investors are busy calculating the adjusted cost base for their ETF holdings. Last year at this time, Justin Bender and I collaborated on a paper called As Easy as ACB, which explains the rather complicated procedure.

An often overlooked part of ACB calculation involves adjusting for reinvested distributions (also called non-cash distributions). As the name implies, these are typically capital gains that were reinvested in the fund rather than paid to investors in cash. At the end of the year these will appear on your T3 slips and you’ll pay tax on them, even though you didn’t actually receive any income. But here’s the step that can get missed: if an ETF has a reinvested distribution, you should increase your cost base by an equal amount, which will reduce your future capital gains liability. If you don’t, you’ll pay the tax again when you eventually sell shares in the ETF.

The curious case of the missing distributions

If you held shares of the Vanguard FTSE Canada Index ETF (VCE) this year, your job is a little trickier. You probably looked on the fund’s web page to see whether VCE had any reinvested distributions in 2013.

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iShares Cuts Its Fees to the Core

That sound you just heard was the latest shot fired in Canada’s ETF price war. iShares has just slashed the management fees on several popular equity and bond ETFs—and just like that the country’s oldest ETF provider has become the cheapest in many categories.

BlackRock has rebranded nine ETFs as the iShares Core Series, “a suite of funds covering key asset classes.” A balanced portfolio of these ETFs now has a weighted management fee of just 0.12% or so, less than half the former cost. (As a rule of thumb, expect the full MERs to be 8% to 10% higher due to taxes.) Here’s what a traditional Couch Potato portfolio might look like when assembled from the Core Series ETFs:

ETF name
Allocation
Old fee
New fee

iShares S&P/TSX Capped Composite (XIC)
20%
0.25%
0.05%

iShares S&P 500 (XUS)
20%
0.14%
0.10%

iShares MSCI EAFE IMI (XEF)
15%
0.30%
0.20%

iShares MSCI Emerging Markets IMI (XEC)
5%
0.35%
0.25%

iShares High Quality Canadian Bond (CAB)
40%
0.30%
0.12%

Total
100%
0.26%
0.12%

The cost of competition

BlackRock launched a family of Core iShares ETFs in the US back in October 2012.

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iShares Advantaged ETFs: Where Are They Now?

Before being bought by BlackRock early in 2012, Claymore Investments pioneered many new services and unconventional products. One of these was its so-called Advantaged ETFs, which used a complicated structure to convert fully taxable bond interest and foreign income into tax-favoured return of capital and capital gains.

Barely a year after these funds joined the iShares family, the 2013 federal budget took aim at this sleight of hand. While the government is grandfathering contracts already in force, it won’t allow new ones, which means the eventual end of the tax break promised by the Advantaged ETFs. A couple of weeks after the budget, iShares stopped accepting new subscriptions for these funds until they decided how to handle the situation.

The ETFs are open for business again, but several have new names and all have new strategies. Here’s a summary:

The iShares Global Monthly Advantaged Dividend has become the Global Monthly Dividend Index ETF (CYH). The tax-favoured structure is gone, but the investment strategy is largely the same: the fund is about half US and half international dividend stocks. However, the older version used two US-listed Guggenheim ETFs as its underlying holdings.

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The True Cost of Foreign Withholding Taxes

Back in the fall of 2012, I wrote a pair of blog posts about the impact of foreign withholding taxes in US and international equity funds. The first explained the general idea of this tax on foreign dividends, while the second showed which funds are best held in which types of account (RRSP, TFSA, non-registered). This is a complicated and confusing topic, so I was surprised at the enormous interest these articles generated from readers, the media, advisors and even the ETF providers themselves.

What was missing from those articles, however, was hard numbers: it’s one thing to say this fund is more tax-efficient than that one, but by how much? To my knowledge no one has ever quantified the costs of foreign withholding tax in a comprehensive way—until now. Justin Bender and I have done this in our new white paper, Foreign Withholding Taxes: How to estimate the hidden tax drag on US and international equity index funds and ETFs.

The factors that matter

The amount of foreign withholding tax payable depends on two important factors. The first is the structure of the ETF or mutual fund.

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Why Has VRE Outperformed Its Rivals in 2013?

It’s been a marvellous year for equities, but 2013 has not been kind to real estate investment trusts. Like other income-producing investments, REITs are sensitive to rising interest rates, and the sharp increase in the middle of this year hit them hard. But the three Canadian ETFs in this asset class have shown significant differences in performance. Notably, the Vanguard FTSE Canadian Capped REIT (VRE) has outperformed its iShares and BMO rivals by a wide margin. Here are the year-to-date returns of the funds as of December 18, according to Morningstar:

Vanguard FTSE Canadian Capped REIT (VRE)
–2.47%

iShares S&P/TSX Capped REIT (XRE)
–7.81%

BMO Equal Weight REITs (ZRE)
–6.72%

REISs pieces

Whenever you see variance among funds in the same asset class, it’s important to determine why. In this case, the main reason is a significant difference in the underlying indexes. Shortly after VRE was launched, I wrote a detailed post describing its benchmark, the FTSE Canada All Cap Real Estate Capped 25% Index, which is quite different from those tracked by the iShares and BMO funds.

Like XRE,

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Ask the Spud: When Should I Use US-Listed ETFs?

Q: Under what specific circumstances would it be better to hold a US-listed ETF if there is a Canadian equivalent? For example, when it is preferable to use the Vanguard Total Stock Market (VTI) rather than the Vanguard U.S. Total Market (VUN)? — R. F.

Until late 2012, there really were no great options for Canadian ETFs that held US and international equities. If you wanted a low-cost, cap-weighted index fund that did not use currency hedging, you were out of luck. That’s why my Complete Couch Potato model portfolio currently uses a pair of US-listed ETFs for its foreign equity components.

But the case for using US-listed ETFs is not nearly as compelling as it used to be. Since April, iShares and Vanguard have launched inexpensive Canadian ETFs covering the broad US and international markets without currency hedging. For example, the Vanguard U.S. Total Market (VUN), launched in August, is virtually identical to the Vanguard Total Stock Market (VTI)—indeed, VUN simply holds units of VTI.

There are three important differences between these ETFs,

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The Hidden Cost of Bid-Ask Spreads

Trading commissions get a lot of attention from ETF investors, and rightly so. But depending which ETFs you use and the size of your trades, the impact of bid-ask spreads may be larger than you thought.

The bid price is what you expect to receive when you sell shares, while the ask price (or offer price) is what you would expect to pay to buy them. The difference between the two is called the bid-ask spread, and it represents the profit taken by the market makers.

Unlike with individual stocks, trading volume doesn’t have a major effect on the bid-ask spread of an ETF. The liquidity of an ETF is largely determined by the liquidity of its underlying holdings: if the fund holds frequently traded large-cap stocks, its bid-ask spread should be very tight even if the ETF itself doesn’t trade very often. If the ETF holds micro-cap stocks or illiquid bonds the spread will be wider even if units trade frequently.

The underlying story

But that’s not the whole story. If the liquidity of the underlying holdings was the only factor, ETFs in the same asset class would have more or less identical bid-ask spreads,

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A Touch of (Corporate) Class

ETFs are generally more tax-efficient than mutual funds, but there is one area where they’re at a disadvantage. Investors who use non-registered accounts can take advantage of corporate class mutual funds, which can reduce or defer taxes. Well, now the country’s newest ETF provider, Purpose Investments, has launched the first corporate class ETFs in Canada.

It’s little surprise the innovation comes from Purpose. The company’s CEO is Som Seif, who founded Claymore Investments back in 2005. Claymore was an ETF pioneer: they were the first to offer pre-authorized cash contributions (PACCs), dividend reinvestment plans (DRIPs) and systematic withdrawal plans (SWPs). Then they teamed up with Scotia iTRADE to offer the first commission-free ETF program. Seif exited Claymore after they were bought by BlackRock in 2012, and it was only a matter of time before he got behind a new project that shook up the ETF business.

Before looking at the new ETFs, let’s review how corporate class funds work. Most mutual funds are structured as trusts. Income flows through to investors and retains its character: in other words,

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