When I spoke with Vanguard’s managing director Atul Tiwari back in June, he said the company would be announcing a new suite of ETFs in the coming months. That announcement arrived late yesterday afternoon: Vanguard will launch five new ETFs before the year is out.
Right now, all we know is the names of the funds and the indexes they track, but that’s enough to get a good idea of their strategies. Here’s my take on the new funds and where they fit in the Canadian ETF landscape:
Vanguard FTSE Canadian High Dividend Yield. No surprise here given the giddy popularity of dividends in recent years. Assuming this new ETF will use a strategy similar to that of the Vanguard High Dividend Yield (VYM), which also tracks a FTSE index, it will focus on stocks with above-average current yields rather than dividend growth. With that in mind, I’d guess it’s likely to be closer to the iShares S&P/TSX Equity Income (XEI) than to any other competitor. The management fee is 0.30%.
Vanguard FTSE Canadian Capped REIT. This real estate fund will go head-to-head with the iShares S&P/TSX Capped REIT (XRE), and with a management fee of 0.35% it’s 20 basis points cheaper. It will track a new benchmark called the FTSE Canada All Cap Real Estate Capped 25% Index, which is a bit of a mouthful. The term “All Cap” suggests the index will include some of the smaller REITs that are excluded from XRE, and the “Capped 25%” indicates that no company can make up more than 25% of the index. That’s significant, because the giant RioCan has occasionally challenged that limit: it currently makes up 21.5% of XRE, which also imposes a 25% cap. I would have preferred a 10% cap to prevent one or two companies from dominating. That’s the reason my Complete Couch Potato uses the BMO Equal Weight REITs (ZRE), which includes 18 REITs with only 5.5% assigned to each.
Vanguard Canadian Short-Term Corporate Bond. This one seems pretty straightforward: it will track a Barclay’s index of corporate bonds with maturities of one to five years. It will face off against the hugely popular iShares 1-5 Year Laddered Corporate Bond (CBO), which has $1.4 billion in assets, the iShares DEX Short Term Corporate Universe + Maple Bond (XSH), and the BMO Short Corporate Bond (ZCS). The Vanguard ETF will trump all of them in costs with a fee of 0.15%.
Vanguard S&P 500 Index ETF S&P 500. Finally, a Canadian ETF that tracks a traditional US stock index without currency hedging. It’s hard to believe this has been so long in coming. (Currently the only other unhedged US index ETF in Canada is the iShares US Fundamental, ticker CLU.C.) I’m surprised and a bit disappointed they didn’t create an unhedged version of the Vanguard MSCI U.S. Broad Market (VUS), which tracks a total-market index with more than 3,200 stocks. But this new ETF will at least allow Canadians to get easy access to large caps without having to trade in US dollars or deal with the persistent drag of currency hedging. The management fee is 0.15%, the same as VUS.
Vanguard S&P 500 Index ETF (CAD-hedged). The demand from advisors for S&P 500 ETFs with currency hedging must be enormous, because this is now the fourth one to appear in Canada if you include the proposed change to the BMO US Equity (ZUE). At least it will be the cheapest: at 0.15% it might even make a dent in the giant iShares S&P 500 (XSP), which charges 0.25% on its asset base of $1.57 billion.
Vanguard has not announced a planned launch date for the ETFs, though I expect it will be in December. (For what it’s worth, Vanguard filed the preliminary prospectuses for its first five ETFs on August 22, 2011, and the funds started trading on December 6.) You can read the preliminary prospectus here.
ETF competition in Canada just got a little more interesting.
It is very good news to hear about the US stock index without currency hedging. I share the same disappointment though as to why Vanguard does not offer an unhedged currency version of the broad US market index VUS. It is puzzling to say the least, since VUS offers so much more diversification than S&P 500 (and S&P 500 is already offered by so many providers, including an unhedged version by td e-funds).
I will be curious to see the difference in assets under management between the Vanguard S&P 500 hedged and unhedged versions as the market decides if currency hedging is worth the extra cost.
@Philippe: As I understand it, many advisors like the name recognition of the S&P 500, which they find easier to explain to clients. That was the major reason why BMO announced that it would start using it as well. We need to remember that DIY investors are not the first priority of ETF providers.
Vanguard has been promoting its total-market funds for a while now, since they seem to agree that the s&P 500 is not the best way to access US stocks, but it will take a long time for investor preferences to change. How else to explain the popularity of the DOW, which makes no sense as a benchmark but is still widely quoted.
Hi, any word on if withholding taxes on dividends will be any different for these S&P 500 ETFs than for XSP for example (where you “lose” them even within an RRSP, if I recall correctly) ?
The Vanguard Canadian REIT ETF is exciting news.
I’m hoping someday for a Vanguard Canadian Small-Cap fund (a cheaper alterative to XCS @ MER=0.53%) or a Vanguard Canadian Real-return Bond fund (a cheaper alternative to XRB @ MER=0.39%).
@Paul G: I am planning to do a couple of posts on withholding taxes, because they remain a very confusing topic. But for now I will say that, as I understand it, if you hold US stocks via a Canadian-domiciled fund in an RRSP, you are subject to the withholding tax and you cannot recover it. This applies to XSP, and it will apply to Vanguard’s ETFs as well.
So if you are an RRSP investor, there is still a tax advantage to holding US-listed ETFs. But you have to balance that against the cost of trading in US dollars. If your brokerage is dinging you 1.5% every time you buy a US-listed ETF, the Canadian alternative might well be more cost-effective.
Agreed, the ETF landscape in Canada just got a lot more interesting , what with BMO’s rapid growth, iShares’ purchase of Claymore and Vanguard’s new offerings. Not surprised really that they’re going after the predictable biggies like Canadian dividends, REITs (which are frankly looking very over-priced here in Canada compared to global REITs) and the S & P 500 hedged funds.
Further to Wendy’s comments though, I’m still amazed at the lack of a half-decent Canadian small-cap ETF. Here’s hoping Vanguard offers one, or Mawer lifts its closed to new investors status on its New Canada fund!
I’m still waiting for Vanguard to bring their Target Retirement Funds to individual Canadian investors.
ie. Canadian equity, U.S. Equity, International Equity, and Bonds, all wrapped up in the same fund with an age-appropriate allocation and a low MER.
@Steve: The lack of liquidity in Canadian small caps probably makes it difficult to build a very low-cost ETF, but I’m sure we’ll see it from Vanguard somewhere down the road. There will be many more ETFs in the next year or two.
@Anon: I don’t expect to see target date ETFs anytime soon. While I agree these are potentially a great tool for retail investors, and for employer-sponsored group RRSPs, advisers don’t like them, and it’s the adviser market that the ETF providers are going after now.
Maybe I’m being naïve, but I kinda get the feeling that Vanguard is on our (individual investors’) side — unlike much of the investment industry.
@Anon: I don’t think you’re being naive at all: Vanguard is indeed the most investor-friendly company in the industry. But they also need to be profitable, and they aren’t going to release a fund that is unlikely to attract assets.
The fact is, target date date ETFs are not likely to be very popular in Canada. They aren’t even all that popular in the US (iShares has a few, but they’re very small). Vanguard’s Target Retirement Funds in the US are conventional mutual funds, not ETFs, and we don’t even know whether Vanguard plans to launch mutual funds in Canada.
Pretty good ETF releases. I will be looking forward to them in the coming year.
Glad to see the Canadian High Dividend Yield ETF :)
Overall, a good line-up Dan.
See you in Toronto at CPFC?
@Mark: You bet. It will be great to finally meet you!
iShares just rolled out some new ETF’s too. They attempt to minimize volatility. Could you do a piece on them? They seem intriguing.
If one wants exposure to US and international markets without currency hedging in a “pseudo-canadian” fund, aren’t you still better with XWD?
There are still no canadian index ETF with international exposure (outside of US) without currency hedging….except XWD which covers both US and international markets.
@Jaz: Yes, XWD is still a good option if you want both US and international stocks with no currency hedging. Actually there is one other option for international stocks without currency hedging: iShares International Fundamental (CIE), though it’s relatively pricey at 0.73%.
I understand the pros and cons of owning the S&P 500 ETF Hedged to Canadian but what is the difference between owning an ETF listed in USD (such as VOO) versus this new Vanguard ETF that is neither hedged nor in USD.
@CK: The difference is that the new Vanguard ETF will trade in Canadian dollars. VOO and similar US-listed ETFs must be bought and sold in US dollars, and the cost of converting currency in a brokerage account can be very high.
will the Vanguard REIT be a mirror image of XRE?
Thanks for the quick reply. I didn’t explain my question well enough.
What are the pros and cons of owning this Canadian ETF as opposed to VOO. I would way rather own this new ETF since I avoid having to make currency conversions but there must be some type of con?
@CK: The most obvious con with the Canadian ETF is the higher management fee. But there are also tax implications if you hold it in an RRSP. This gets a bet technical, and I am planning a future post on the topic, but the short answer is that the Canadian ETF will incur the 15% withholding tax levied by the IRS on US dividends. If you hold a US-listed ETF in your RRSP, you are exempt from this tax.
If you are holding the ETF in a taxable account, it doesn’t matter, because the withholding tax is recoverable.
@Jaon: No way to know that until the index details are published, but the two ETFs are likely to be very similar in holdings.
Within my ‘TFSA’ would you recommend this new Vanguard ETF over XSP for sure?
@CK: The tax situation is the same for both ETFs. The only difference is the currency hedging, and that decision depends on your preference. Personally I don’t value currency hedging, but some people may have reason to want it.
Getting an unhedged US market ETF is really good news. I just read the following article that exposes XSP’s epic failure to provide effective currency hedging from January 2006 to December 2011, due to an annualized 2% tracking error!
What happens to this S&P 500 unhedged ETF if the Canadian Dollar plunges vs USD?
@CK: You get a boost in your returns, as measured in Canadian dollars. Same as would have happened had you bought a US-denominated ETF.
Wow, I’m sort of wondering if I made a mistake in opening a qTrade USD account to hold VTI. That currency conversion charge looks pretty huge now.
age appropriate allocation, this term is really irritating, what has Age and Investing got to do with each other?
I have a 52 year old friend with $5,000,000 in the bank, earns $800,000 annually, has a Mortgage Free $2,000,000 home and is married to a Teacher who is taking her PV of her pension , worth $600,000 and retiring.
This guy is 100% invested in Bonds, corporate, five year ladder.
My other friend is 75, gets GIS, lives a simple life in a cabin with no debts, heats with wood, grows own vegetables, just inherited $200,00 which is 100% Stocks.
He does not want the money, so it is for his estate.
JNJ,TYC,PFE,MMM, TRP, ENB, XFN,CDZ.
Lest risk to meet your needs, regardless of age.
I am almost 70,my portfolio, with the age mantra, is that of a 30 year old,we don’t need the money,it is for our Estate.
Set up,never look at it DRIP what we can.
On Page 28 of the Vanguard Prospectus the actual MERs of its index ETFs are given. These numbers are much higher than the management fees. For example the management fee for VCE is 0.09 % but the MER is 0.69%. An explanation is given that is hard to understand but it seems to be due to the funds start-up costs and relatively modest level of assets. Two questions. Do the investors pay these fees? Would this be a reason not to invest until the ETF has been trading for awhile?
@Amir: It’s nothing to worry about. The Vanguard ETFs launched in November and would have incurred some one-time start-up costs that month and in December. The 0.69% is annualized figure for 2011 that assumes those start-up costs would have been the same all year long, which of course is not true. In any case, Vanguard seems to have absorbed all costs beyond the stated managed fee so investors would not have paid that cost.
I’m not sure what VCE’s returns were in November and December last year, but for the first six months of this year, the tracking error is actually lower than what you would expect. This is from the Management Report of Fund Performance:
In regards to REITs, you say, “I would have preferred a 10% cap to prevent one or two companies from dominating.” do you think your preference will change from ZRE towards Vanguard FTSE Canadian Capped REIT taking it’s 20 basis point savings?
You picked RWO in The Über–Tuber, when would it make sense to switch from a Canadian REIT choice to an international one like RWO?
@Que: I’ll reserve judgment on the Vanguard REIT until after I know the index methodology. The lower MER is great, but I still have a problem with any fund whose top holding is 25%.
The Uber-Tuber is based on the strategies used by Dimensional Fund Advisors and their real-estate fund is global, so that’s what I mimicked. For a large portfolio (say, $1 million or so) I would definitely think about splitting my REIT holdings between Canada and international (or at least US). The sector is just so small in Canada and I worry about single-company risk.
So between VUS, which has broader market exposure, but hedges and is tax inefficient in an RRSP, and the upcoming Vanguard S&P500 fund, which ditches the hedging (and the tax impact I believe will still be negative), which would you recommend as a core US holding?
@Danno: I’d estimate that any additional return that might come from the added diversification of mid- and small-cap stocks in VUS would be overwhelmed by the drag of currency hedging. So the unhedged S&P 500 fund would be my preferred choice.
Interesting, thank you. I suppose I’ll have to wait a few months for more information and fund details to emerge, then perhaps consider whether I might like to switch.
Presumably the two S&P 500 ETFs you mentioned here will also be affected by the switch of indexes that Vanguard has announced. Have you heard any confirmation of whether these ETFs will also follow a CRSP index instead?
@Dave: Vanguard has not announced any plans to change their S&P 500 funds. The only changes are to funds that used MSCI indexes.
Anyone know when Vanguard will be releasing these new ETF’s?
@JoeK: They have not announced the date yet, but I would expect them in before the end of 2012.
It looks like they started trading Nov 8th! However, the holdings are not shown anywhere yet.
They are listed on their website now as well!
Above you said you’d prefer the unhedged S&P500 fund (appears now to have ticker VFV) to VUS. I currently use VUS as my core US holding. When a new fund becomes available like this, do you recommend any sort of delay or wait period prior to moving in? If so, how long, and what are we waiting to see?
@Danno: When a brand-new fund appears (especially if it is tracking a new index) I often like to wait a year until it has some economies of scale, and to see whether it tracks its index well. But in this case that’s not necessary, because VFV simply holds a US-listed ETF that is enormous and has been around for a long time.
Thanks a lot. So I gather this is just holding VOO then? It looks like the details on the Vanguard site are not fully posted yet.
@Danno: Yes, both VFV and VSP will have VOO as the only underlying holding.
I see that Vanguard has set up a DRIP. How will this work with TD?
@Pancho: Just call TD Waterhouse and ask them to set up a DRIP on any Vanguard ETFs you may hold. This is actually possible with most Canadian-listed ETFs already:
Which ETF would you recommend to provide some US small-cap exposure to a portfolio whose equities are comprised of: VFV, VXUS and ZCN? I’m having a hard time figuring out the difference between VB (Vanguard small-cap) and VBR (Vanguard small-cap value).
I hear there are plans for a new CAN-listed Vanguard ETF which tracks the entire US market (as opposed to S+P 500) unhedged. However, if one would like to add a slight small-cap bias to one’s equities, I figure it’d be helpful to allocate an additional ~5% to this type of investment.
@Jamie: VB tracks small-cap stocks in general, while VBR tracks small-cap stocks considered to be “cheap” according to the traditional value characteristics, such a low price/book and price/earning ratios. So VBR gives you a small-cap tilt and a value tilt.
Another option would simply be VTI, which tracks the whole US market. Vanguard Canada may soon be offering a version of this ETF with no currency hedging, but there has been no formal announcement.
Thanks for the response Dan. Would VTI (or the Canadian version) on its own, offer a small-cap or value ‘bias’ ? I recall your book on ETF’s mentioning small-caps with historically greater returns (with a large enough portfolio), I guess my question is, is owning VTI by itself enough or should one consider an additional ~5% of total portfolio in an ETF like VB or VBR to get a ‘bias’ toward small caps?
For the record I have about 20% of portfolio in each of US, Can and Int’l equities.
Thanks again, great blog.