Vanguard Canada launched some new ETFs this week, and I spoke with managing director Atul Tiwari about the funds. Let’s take a closer look.
The Vanguard FTSE Canada All Cap (VCN) expands on the older Vanguard FTSE Canada (VCE). While VCE holds 78 large-cap stocks, the new index includes 255 holdings and covers 96% of the Canadian equity market. That makes it roughly equivalent to the S&P/TSX Composite Index, which holds 234 companies and claims 95% coverage.
This is about as close as you can get to a total-market index in Canada: dig further and you run into serious liquidity problems with small, thinly traded stocks. “We started out with a very large universe and pared it back to a number we thought would be terrific,” Tiwari explains. “But once you get to the practical aspects it gets pretty tough. Our partners on the capital markets side, who are creating units and doing the market making, have to be comfortable they can find these securities. Obviously there’s a cost associated with that, and at some point it gets too unwieldy and it doesn’t make sense.”
With a management fee of just 0.12% (the MER will be a few basis points higher), VCN is now the cheapest broad-market Canadian equity index fund available.
USA all the way
The most significant of the new ETFs is the Vanguard U.S. Total Market (VUN), a long-awaited Canadian version of the Vanguard Total Stock Market (VTI), which holds about 3,500 stocks and blankets 99% of the US equity market. Vanguard’s initial launch in 2011 included a version of this fund with currency hedging (VUS), but this new ETF is not hedged to Canadian dollars.
VTI is a core holding in my Complete Couch Potato portfolio, but VUN may be a better alternative for most Canadians. While VTI’s annual fee is just 0.05% (compared with 0.17% for the two Canadian versions) it must be bought and sold in US dollars, which adds a significant cost. Even if you use Norbert’s gambit, you should expect to pay at least 0.20% to convert loonies to greenbacks, and if you’re accepting your brokerage’s normal foreign exchange rates—as many investors do—that cost can easily be 1.5% each way, which wipes out any advantage for VTI.
There are a couple of other factors to consider when deciding between VTI and VUN. The US-listed version is more tax-efficient in an RRSP, because it is not subject to withholding taxes: these would cause a drag of about 0.30% (based on a 2% yield). On the other hand, the Canadian-listed version is not vulnerable to US estate taxes, which may a boon for wealthy Canadians.
Smaller investors will also appreciate that Vanguard has set the unit price for VUN around $24, which makes it easier to buy small amounts and use DRIPs. (After the run-up in US markets, VTI now trades at a lofty $86 a share.)
Over the hedge
Also new on the menu is the Vanguard FTSE Developed ex North America (VDU), an unhedged version of Vanguard’s existing international equity fund (VEF).
Not long ago, index investors were asking why it was so hard to find an international equity ETF without currency hedging, but iShares changed that in April with launch of the iShares MSCI EAFE IMI (XEF). In doing so, they scooped Vanguard. “We definitely would have been out earlier with these unhedged products: we had them in our product plan from the start,” Tiwari says. “But we couldn’t actually come out with them because we knew we were transitioning out of the MSCI indexes. It wouldn’t have been right to launch them and then very quickly make the change in indexes. ”
Vanguard has also dropped the management fee on two existing ETFs. The cost of VEF has declined to 0.28% from 0.37%, while the Vanguard FTSE Emerging Markets (VEE) now charges 0.33%, down considerably from 0.49%. Tiwari says these fee reductions were the result of some growing economies of scale, and the new relationship with FTSE: Vanguard did promise that lower index licensing fees would be passed on to investors. But I can’t help but think competition also played a role: iShares’ new international and emerging equity funds were launched with very low fees (0.30% and 0.35%, respectively) and it’s probably not a coincidence that Vanguard’s products are now two basis points cheaper.
@Dave: Thanks for the comment. I do worry that a lot of other investors are buying US-listed ETFs without paying attention to currency exchange. Even if you’re aware of the costs, there’s no simple solution. Norbert’s gambit can be complicated, and it’s not practical unless you’re exchanging fairly large sums. So good on you for recognizing that.
If you’re at Questrade and you’re buying and selling without commissions, it’s probably worth using separate ETFs for US and international equities rather than using XWD. Have a look at VUN and XEF: both provide better diversification and lower cost than XWD.
Thanks very much for replying!
I had considered VUN and XEF, but do you think I’m losing out on a lot of potential by skipping emerging markets? They seem like such an important part of a healthy portfolio.
@Dave: I don’t suggest dropping emerging markets: I was suggesting that 20% VUN and 20% XEF is likely a better choice than the 40% holding in XWD. The 10% in XEC and everything else can stay just as you outlined.
Oh! I misunderstand, that makes sense now. Thanks!
@Dave: I am also looking at Mawer Balanced, specifically for a RESP account and a non-registered investment account.
@CCP: I think I read elsewhere on your site that with RESP, and accounts with less than $50k, it’s better to find a low fee mutual fund, is that true? Have you looked at the Mawer funds? For the RESP in particular, the Balanced Fund or even Global Balanced Fund looks alright. No rebalancing required. Seems easy and the MER is at about 1%.
@Matthew: Yes, I definitely agree that low-cost mutual funds are preferable to ETFs for small accounts (which includes almost all RESPs). Even as a committed index investor, it’s hard to find fault with the Mawer Balanced Fund, which is priced like an index fund, is globally diversified, and has a long history of prudent management.
You may also find this interesting, though it’s not an option for RESPs:
Holding a balanced fund in an RESP is ideal in the early years, but as the child gets closer to high school a 60% equity mix is likely too aggressive. You can’t the change asset allocation when you hold a balanced fund. However, you can simply add a cash component to the RESP and use that to control the overall mix: for example, you could lower the risk by keeping 70% in a balanced fund and 30% in cash.
In a non-registered account, balanced funds are quite tax-inefficient because of the large bond component. Not a big issue if the account is small and you’re in a low tax-bracket, but certainly a concern for some investors.
Seeing that VUN and Mawer Balanced Fund both won a Morningstar award last night, sounds like both are decent choice.
With the recent predictions that the Cdn dollar will be at below 90 cents by the end of next year, I wonder if that is another good reason to invest in the US – VUN or VTI.
RE: your concerns about forex costs at Questrade. Vitual brokers allows you to
hold U.S. $’s in registered accounts for $50 per account. Therefore, you can
make purchases from the U.S. $ accounts and receive U.S. $’s into these accounts
without having to go through forced conversions. This is another option for you to
investigate. You can see this under administration fees from the VB homepage.
@Ross Questrade does support USD RSP’s. In Dave’s situation though, I think he should stay simple and stick with Canadian ETFs as @CCP suggested if he doesn’t want the hassle.
For VUN, will it cost me only one level of withholding taxes (15%) if I have it in an RRSP account? Also, I have $50000 in TFSA between my wife and I, and $22000 in RRSP. Would it be wise to put bond etfs in RRSP account first, and then US equities? Thanks.
@sn: Yes, only one level of withholding taxes on VUN. Your other question is hard to answer without complete details, but the short answer is, it probably makes very little difference at this stage. Asset location is much more important when the choice is between registered and non-registered accounts. The RRSP vs. TFSA question is less important.
Are you at all concerned that VCN’s market cap is just $20 million?
@ETFinvestor: VCN is barely a few months old! Give it a chance.
My opinion: It is the best Canadian ETF you can wish for.
I’m still a little confused by VUN vs VTI. I would like to buy one and have it sit in my RRSP for the next 15 years. Which is the better long-term choice?
@Erin: If you are making only the initial purchase and never adding new money for 15 years, then VTI will almost certainly end up being the better choice, even if the currency conversion is costly at the beginning. If you are adding new money to it every year, however, chances are the transaction costs will exceed the savings you’d get from the lower MER and the withholding taxes. More here:
Are the only costs of hedging the MER, TER, and tax treatment mentioned in this post?
Hedging seems to cause tracking errors that are much much higher (see http://www.canadiancapitalist.com/why-currency-hedged-funds-have-large-tracking-errors). You reviewed the research paper referred to in the link (according to a comment from CPP on that blog). What were your conclusions?
@Rob T: Currency hedging costs do not show up in the MER or TER. The actual transaction cost of hedging is very low: it’s the cumulative tracking error that is the true cost. (The tax inefficiency is also a concern in non-registered accounts, of course.) I have long argued that currency hedging is usually unnecessary for long-term investors for that reason.
@CCP: Sorry, I meant hedging costs showing up as the difference in MERs (between the hedged and unhedged versions of a fund), not the MERs themselves.
These tracking errors occur when the a funds currency hedge differs from the value of its foreign stocks (due to stock price fluctuations). But wouldn’t this kind of tracking error tend to even out over time (as opposed to being cumulative)? If a fund inadvertently has foreign currency exposure from time to time, wouldn’t it be as likely to make them an inadvertent forex profit as it would a loss?
How large would you say the performance penalty is for a hedged fund (assuming it is done in an RSP)? Whats the calculation?
@Rob T: There isn’t necessarily a difference in MER between hedged and unhedged versions. VFV and VSP are the same, as are ZSP and ZUE.
You would think the tracking error would even out over time, but that hasn’t been the case. I did the calculations for XSP from 2005 through 2012 for my book, The MoneySense Guide to the Perfect Portfolio. There was a negative shortfall every year, ranging from -0.4% to -3.5% and averaging -1.9%. The good news it seems to be getting smaller, and in 2013 it was positive for the first time (+0.2%).
So I have redone my portfolio (150K), but my challenge is that I have no RRSP room or TSFA room due to DBP.
Knowing that our dollar is low and not wanting to mess with Norbit’s, I decided to take the less tax efficient approach and put VUN and XEF into my RRSP (not ideal due to withholding tax, but the dollar exchange rate drove me to this). I have VCN in my non-registered account and CDZ in TSFA.
I have higher risk tolerance combined with a solid DBP-so have opted out of bonds for now…but will be transitioning 20% over in the next few years.
My thoughts are when the CND dollar improves I may be better positioned to change over to VTI and VXUS in my RRSP, but since I am saving more in my non-registered account, I am assuming I take the decreased 1-2% return due to the tax inefficiency.
Am I nuts?
@DF: You’re not nuts, but I think you may be misunderstanding a key idea regarding currency exposure. The CAD/USD exchange rate has absolutely no effect on the decision between VTI and VUN, or on the choice between VXUS and XEF:
Guess I am another “Gerry”. So I am in a pickle…from your experience, should I stay as allocated until years end or transition into VTI and VXUS using Norbert’s gambit? I did like the low trading fees of VUN and XEF, but since I have a 18 year horizon before retirement, taking a small loss to ensure right fund allocation for future taxes seems reasonable.
@DF wrote “My thoughts are when the CND dollar improves…”
Bad assumption. Are you clairvoyant? :) Don’t assume you know what will happen. If anything there are a few strong arguments that it will go lower. 1.) the Canadian dollar was abnormally high compared to it’s historical rates 2.) the Australia Dollar has dropped even more relative to the US Dollar and it’s also seen as a commodity currency, so Canada has quite a bit more to go down by that measure 3.) there is a huge short interest on the Canadian dollar right now 4) the government wants it lower to help manufacturing, so the Bank of Canada won’t jump in to support it with buying.
But even having said the above, I don’t assume I know what will happen. Huge short positions sometimes go south and cause an equally strong rebound. You never know.
This is why having a diversified global portfolio with unhedged ETFs is a good thing at any time. Pick your allocation and ease into it.
I understand how using international ETF’s is important for portfolio diversification but I find it hard to invest in countries that I don’t know/understand. For example XEF has 22% allocation in Japan. Except for very general geographical and historical knowledge, I know very little about Japan, Australia and Singapore for me to feel comfortable in investing there. I’ve recently started to follow Europe and now I’m thinking about adding XEU to my mix of Canadian and US ETF’s. Is adding XEU alone under my circumstances :) a good idea or should I still go for a more geographically diversified ETF? If yes, any other European ETF’s you could recommend?
@Bibi, I think you may be asking the wrong questions. A core principle of passive index investing (as promoted by this site) is that the market is better at determining fair value/pricing than you are. Thus an index investor you should just “buy the market” rather than trying to pick winners and losers.
If you a true believer in indexing, the percentage you should hold in each country should just be equal to the market capitalization of each country.
Once you move off of those weights, you aren’t passively indexing anymore and it’s really your judgement call. E.g. some people prefer to invest more in Canada than the global market cap would suggest, etc.
@Brian G Maybe you’re right. I’ve spent last 5 days reading articles and looking at charts and trying to find the right questions. Please take a look at the calculated ccp models returns at https://canadiancouchpotato.com/wp-content/uploads/2015/01/CCP-Model-Portfolios-Vanguard.pdf
The interesting fact that all models have almost the same 20 year annualized return around 7.5%
So with all that diversification and different investment approach you get the same result.
I don’t know how accurate this site is:
but it gave me 9.86% as 20 years annualized return of S&P 500.
What am I missing?
@Bibi writes, “What am I missing?” When comparing portfolios look at the volatility (which a proxy measure for risk) first and the return second. For example in the CCP PDF, look at the row labelled “Lowest 1-Year Return”; it varies from -7.8% to -30.6%. The SP500 in 2008 was even worse at -37.2%.
While a SP500 only portfolio may seem better at 9.8% than only 7.5% remember that higher return came at cost of greater volatility.
Finally, remember that nobody can predict the future. Who knows if that funny 7.5% coincidence for all CCP portfolios will repeat itself (unlikely) or if US stocks will continue to outperform. Who knows when interest rates will rise and cause bonds to drop in value. When you can’t predict the future, the old adage of not putting all your eggs into one basket seems to be a good guiding principle.
Think about how much volatility you can stomach in your portfolio and still sleep at night then pick a portfolio allocation accordingly.
P.S. While I like the CCP portfolios, don’t forget that cash or GIC’s can be added to them as well.
I hope this helps.
@Brian G Yes thanks.
“P.S. While I like the CCP portfolios”
Before my reading spree I had VTI for my US exposure and looking to add international exposure. 2015 models have changed dramatically. If I were to remodel my portfolio I would need to sell VTI convert USD to CAD and by VXC. That’s a very big move for me but I’m afraid if I don’t do it I may not be able to use many resources on CPP. Have you moved to the new models?
@Bibi, no need to sell VTI and incur all those costs! I think you may not be thinking big picture and may be hung up on the details (e.g. what particular funds to use.)
Constructing a passive index portfolio (like the CCP) is just about determining your target asset mix (e.g. percentage of bonds, Canadian stocks, US stocks, international stocks, etc.) you want to hold based on your risk profile and then picking some investments that get you to those percentages.
Click on the Model Portfolios tab above to see many ways it can be done. Or look at Justin’s post here http://www.canadianportfoliomanagerblog.com/model-etf-portfolios/ for more examples.
For example, if you already have North American exposure and want to add developed international exposure you could just add VDU, ZEA or XEF to what you have.
What’s important is that you have an asset mix that matches your risk profile. The exact funds you use is much less important so don’t worry about it too much. Once you have your asset mix you want, stay simple and don’t churn your portfolio. Just make small adjustments as you go.
Depending on you situation, because you seem to have some questions you may want to seek the advice of a for fee advisor like PWL. Alternatively, do more reading and you’ll get it. You may also want to Google Bogleheads or Canadian Financial Wiki, etc. Knowledge is power, so learning this stuff is worth it. Never fully trust anybody with your money; you have the greatest vested interest in it. :)
Thanks for an informative website. I have a question regarding the exchange rates for buying VTI, TDB952, etc etc. The question is, do you know what the institutional x-rate is that Vanguard, TD etc are using to buy US domiciled funds?
I know it’s cheaper to buy VUN, TDB902 etc when purchasing in Canadian dollars, rather than buying the US dollar denominated equivalents (thereby avoiding the retail spread of 1.5%), but without knowing the estimated institutional x-rate spread that the brokerages are using, it’s hard to make a true comparison.
If institutions buy the underlying US domiciled securities at an x-rate of 0.1%, that’s a big difference to say, 1%, but obviously still a lot better than 1.5% on the retail side. Without knowing this number, it’s hard to do all the math on (for instance) VUN vs VTI, since this variable is a requirement to the calculation.
Anyway, just wondering if you know the answer. I asked TD, but they didn’t want to give a simple answer.
@Luc: Institutions like Vanguard and TD pay negligible foreign exchange costs. I would be surprised if it was one basis point. This is definitely not a factor you should consider when deciding between various funds.
@CCP: Thanks! That was the answer I was hoping to hear. Have a nice weekend.
A thousand thanks for this amazing website! I’m a rather novice investor despite having invested in a few ad hoc none-registered, RRSP and TFSA accounts. Currently, I have 25k in none-registered regular savings account (mostly transferred back from foreign income as I was working abroad for a couple of years). 20k in a regular TFSA bank account. And about 5k in a RRSP mutual funds portfolio and 10k in a TFSA mutual funds portfolio. Both my mutual funds portfolio are relatively new (apx 2 years) and have over 2% MER, thus returns have been virtually none-existent especially given recent market trend…
I purchased a BMO investorline account very recently (last week) but have yet to begin making any trades (been studying the art!)
I plan to keep around 30k as liquid asset for down payment on a condo within the next two years (and I will not be needing this money for any other purpose).
How would you recommend me to consolidate my investments for the loooong run if I am leaning towards much more aggressive growth? I am an aggressive saver who is just about to enter my thirties and is most comfortable with minimal monthly contributions (200-500$) with a lump sum annual contribution before tax season to maximize tax deductions.
I am not in the high income bracket and given that my work provides with a cohesive but young pension plan (again, just returned to Canada a year ago), further RRSP investments would likely not be a focus at this time.
Until now, my investments have been a bit scattered and is looking for a major restructure that would set met on the right path for the long run. Your thoughts would be much appreciated!
@Al: Glad you’re finding the blog useful. It’s really not possible for me to be too specific with my advice. In general, it sounds like you’re doing the right thing by keeping your short-term money safe and liquid while treating your long-term savings separately. If you’re already at BMO and you’re planning to use ETFs, I think your biggest obstacle will be trading costs: ETFs are really not appropriate for $200 to $500 monthly contributions when you’re paying $10 per trade, so be careful not to trade too often. Above all, try not to got too focussed on creating a perfect plan. Just keep saving, diversify broadly and keep your costs low.
Just doing a rebalance of my portfolio and I need to add to the US equities side. Normally I use VTI and have been in both the RRSP and the Non-Reg. accounts. I do use Norbert’s Gambit but it is getting more expensive at TD to do this now. An extra $40 on the second half of the trade if I recall correctly.
So I’m wondering if, for Non-Reg. accounts if I should just use VUN in my $cdn non-reg. acct instead of coverting to $US and using VTI in my non-reg $US acct? Seems like no hassle with conversion even with Norberts Gambit but at a cost in MER. Don’t see any other advantages or disadvantages.
Would you prefer to use vti or vun for a resp?
@Dae: There is no advantage to using US-listed ETFs in an RESP. Always use Canadian-listed funds.
I plan on making regular contributions over a period of about 20-30 yrs. Questrade has free ETF buys of course so I’m not concerned about being fee’d to death. I’m just hung up on which ETF to buy.
VFV which follows the S&P 500 unhedged with a MER of .08%.
VUN which is total US market w a MER of .16%.
I’ve read that VUN is preferable due to being more diversified and holding more mid cap and small cap stock. I’ve also read that although there is some slight variation, both ETFs do about the same. So my question is, is VUN worth paying double the MER for such similar results although more diversified?
I should note, that I am not considering buying VTI or VOO in USD. I do not plan on holding these ETFs in an RRSP because I am one of the lucky few with a great pension and my retirement income won’t be too much lower than my working income. Also, because my contributions will be consistent and small (500 biweekly), Norbert’s Gambit won’t be beneficial to me. For a little background, I do currently own some VGT + VXUS in my RRSP but they are not my main focus.
@Mike: This is a small decision: the expected returns are likely to be very similar over the long term, since the S&P 500 makes up about 70% of the US market. Historically, the inclusion of midcap and small cap stocks has added significantly more than 0.08% to returns, so in my view it’s preferable to use total-market index funds. But either choice is perfectly fine.
Thank you for the quick reply. VUN it is!