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.
Cross-Canada coverage
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.
This is good news. However, will the tax leakage that occurs when one buys Canadian wrap versions of US listed ETFs that invest outside the USA also apply to VDU?
The following is from a previous post on CCP.
http://www.financialwebring.org/forum/viewtopic.php?f=38&t=115256&p=475999#p475999
In other words, if BlackRock/BMO/Vanguard did the necessary paperwork using CRA rules, Canadian owners of these ETFs might be able to get credit for foreign tax paid. They also might be able to claim capital gain distributions and return of capital distributions as capital gains and return of capital respectively, and not as the equivalent of interest income.
TD EAFE efund (mutual fund) has $256 million in assets and an MER of 0.51%; it has the tax efficiencies mentioned in the last paragraph. XIN, iShares EAFE fund (ETF), has $862 million in assets and an MER of 0.50%; it has none of the tax efficiencies mentioned in the last paragraph. And a mutual fund structure is more costly than an ETF structure. If TD’s fund can do it, why can’t XIN?
CCP,
Does this change any of our Model Portfolios? Why or why not?
@Jason: I try not to make changes to the model portfolios more the once a year. New products are released every couple of months (or fees get reduced on existing ETFs)and it’s easy to fall into a pattern of buying and selling every time something new arrives on the scene.
Between VDU and XEF, which of the Canadian international ETF products is better? I know one has lower cost, but XEF holds more securities.
Hi CCP,
I hold VUS currently, however, I would prefer the unhedged version (VUN). Do you expect the performance of VUN to be slightly better since it is not subject to currency hedging drag (tracking error)? Obviously you introduce currency risk by having the unhedged version, but this does not concern me overly. Also, I presume the dividend yield of 1.47% for VUS will be the same for VUN…
For instance:http://www.pwlcapital.com/en/Advisor/Toronto/Kathleen-Clough-Justin-Bender/Blog/Justin-Bender/September-2011/Vanguard-Canada-initial-ETF-offering-falls-short
So, do you think that the Complete Couch Potato portfolio should be updated to replace VTI with VUN?
It sounds like, for most people, VUN will be the better option due to the exchange fees alone.
CCP,
As I only balance once a year (early in the year) I will not be making any trades to move into VUN for some time but I am wondering, should I perhaps stop the DRIP of VTI now so that I do not continue to lose money on the exchange fees as it looks like (all things staying equal) I will be moving over to VUN early next year.
Thoughts?
@Dave: I tend to prefer total-market indexes whenever possible, and XEF gets closer than VDU. (I expect Vanguard Canada will come out with a version of VXUS at some point.)
@Andrew: The relative performance of VUS and VUN will depend primarily on the USD/CAD exchange rate. In general, currency hedged funds tend to have higher tracking error, but during a period when the Canadian dollars trends strongly higher, VUS would still outperform.
The message of the blog post you linked is that, contrary to popular belief, hedging foreign currency does not actually lower a portfolio’s volatility: it increases it without increasing expected returns.
@Michael: The original post explains the situations where VTI or VUN would be appropriate. It really depends on the individual.
To address your other questions, whether or not you use a DRIP has no effect on the currency issue. If your brokerage allows you to hold USD, there is no conversion whether you receive the dividends in cash or new units. And if the brokerage does not allow US dollars (in an RRSP, for example), then the currency is converted in both cases. But if you are planning to switch, then yes, it is probably a good idea to cancel the DRIP now, or at least after you receive the third-quarter dividend.
This is good to see. Looks like VCN may end up being better than ZCN with the all-cap approach.
Regarding VTI and VUN, once exchange rate is taken into consideration, both should perform the same, correct?
There shouldn’t be any tracking error or surprises waiting for us at retirement, I hope.
It would be good news if the Canadian version of VXUS is available, this way all of the foreign withholding tax will be recoverable, since I invest in taxable account.
@David L: The only difference between VTI and VUN should be the latter’s slightly higher cost and potentially higher withholding tax if held in an RRSP.
A Canadian version of VXUS would not be more tax-efficient than the US-listed version unless it held the stocks directly, which is not going to happen. Even with a Canadian “wrapper,” the US portion of the withholding tax would be recoverable and the international portion would be lost.
I’m a new couch potato, just setting up my portfolio.
If I’m buying and holding VTI in my RRSP for the long term, would the 0.2% cost of using Norbert’s gambit not be far less significant than the 0.3% annual drag of the withholding tax since the currency conversion only occurs twice (buying and selling) and not annually?
Could one buy VUN and have it “journaled over” to VTI? Would this be simpler than using Norbert’s gambit with say DLR and DLR.U and then buying VTI since since holding VTI is the goal anyway?
@Henrik: Yes, in theory, VTI is cheaper in the long run if you execute Norbert’s gambit perfectly (and don’t forget to include the commissions to buy and sell DLR). The question is how much work you want to do to capture what is likely to be a very small saving. I’d encourage you to do the math with dollars rather than percentages before making the decision. I put this in the category of things you need to worry about only after you’re sure you’re doing everything else right.
No, you cannot journal VTI to VUN. These are not cross-listed securities: they are different products.
I just opened up a BMO investorline account yesterday. Still waiting on the transfers but as someone who is about to pull the trigger on the couch potato strategy, what would you recommend as a model portfolio? Would you recommend using the new VUN and VCN as part of it? I’ve got 100k+ to invest and a long time horizon, however I’m not really comfortable getting fancy with Norbert Gambit’s, so I’m not ready to invest in US dollars just yet..
By the way your blog has been very helpful in getting me to this point. Although a lot of it goes right over my head I find that I am going back and re-reading some key posts over and over! Thanks :)
I hold all of my slightly modified Complete Couch Potato ETF’s inside of my RRSP, are there any recommendations specific to which ETF’s are best in RRSP’s? I am particularly worried about losing tax money needlessly. Currently I have TDB661 (For monthly accumulation purposes), ZCN, XEF, XEC, ZRE.
@Newbie: Congratulations on taking these important steps. You might consider something like the Complete Couch Potato since you’re over the $100K mark. Please note, however, that the overall stock/bond mix may or may not be appropriate for you:
https://canadiancouchpotato.com/2010/11/10/ready-willing-and-able-to-take-risk/
If you’re not comfortable trading in US dollars, VUN is an ideal substitute for VTI. There is no perfect Canadian-listed substitute for VXUS, but XEF (from iShares) is a reasonable stand-in. It does not include emerging markets, but it’s fine for now.
Above all, I urge you to keep things simple and don’t sweat the small stuff.
@Jeff: There is no tax issue with Canadian equities (such as ZCN and ZRE). With foreign equities, US-listed ETFs are more tax-efficient than Canadian mutual funds or ETFs (such as TDB661, XEF and XEC), but that’s only one factor. By using Canadian products you are avoiding currency conversion, which may be a more significant savings. You also have the convenience of contributing to a mutual fund to reduce your trading commissions. I’d encourage you to just keep doing what you’re going and don’t dwell on the withholding tax.
CCP,
Thank you so much, big relief to know I am on the right track!
Normally, when you sell a stock, there is a capital gain or loss.
Given that VUN is the unhedged version of VUS with exactly the same holdings, can one simply transfer from one to the other without triggering a sale?
If not, these new Vanguard additions would only be good for new money.
@Marc Neeb: You cannot transfer from VUN to VUS, or vice-versa. They are two different securities.
I would argue that if you were planning to switch from one fund to another anyway, triggering a capital loss is a good thing. If you can’t use it to offset a gain this year, you can carry it forward indefinitely.
Good products Dan and thanks for the overview.
To clarify, if I was to keep VTI in my CDN $ RRSP, that’s OK as long as I don’t DRIP this? Otherwise, not only do I have the exchange costs on VTI distributions to deal with but also the exchange costs on VTI DRIPs?
For this reason, I’m thinking it might be time to start buying VUN inside the RRSP and stop DRIPping VTI.
I have to date kept only U.S.-listed ETFs in my RRSP (like VTI) because they are tax-efficient (over CDN-listed ETFs holding U.S. stocks).
Thanks Dan,
Mark
@Mark: Thanks for the note. Using a DRIP with VTI would actually be a good thing, because it would help you avoid currency conversion, as Canadian Capitalist explains here:
http://www.canadiancapitalist.com/how-to-avoid-currency-conversions-on-us-dividends/
But this is an extremely minor issue, as CC also points out:
I realize now that what I said in the post about DRIPs may have been unclear. I meant to point out that VTI’s high share price (over $86) means you will need roughly $20,000 for the quarterly dividends (about $0.38) to be large enough to buy just single share. VUN’s share price is less than one third of that, so DRIPs are a little more efficient. I wrote about this idea here:
https://canadiancouchpotato.com/2012/12/31/ask-the-spud-do-i-have-enough-for-a-drip/
Great summary as always. I’m curious to see if you think that VCN changes the function of XMD, as you discussed here: https://canadiancouchpotato.com/2012/03/22/under-the-hood-ishares-sptsx-completion-xmd/
Will VCN offer a more complete CDN exposure as compared to a HXT + XMD? I currently split HXT (as the cheapest CDN core holding) and XMD (as a small cap tilt). As XDM holds the 191 companies not in HXT, I believe this combination should be identical to the VCN holdings, with the advantage of control oer small cap holdings, but at a slightly higher MER. Am I missing anything?
Thanks for the quick response Dan.
I use DRIPs for almost all my holdings (registered and non-reg) so CC’s post was good to read again. I don’t have substantial VTI holdings, just barely enough to DRIP, but based on your clarification, it might not be worth shutting off the DRIP tap for VTI.
Might as well just stick with the plan: VTI remains an excellent holding for the CDN $$ RRSP or USD $$ RRSP.
Vanguard Canada is definitely making waves though. This can only help create more awareness about indexing and Couch Potato Investing in general – which is a good thing.
Mark
Another great article Dan!
I am a newbie investor and just about to make the switch from funds to ETFs. I am at the begining of my working career. I understand that by rebalancing my portfolio every year, I am helping to force myself to buy low and sell high. What is your oppinion on holding XEF and XEC versus potentailly waiting for a canadian version of VXUS? A fund like VXUS would be more convinient and save on trading costs, but am I losing the opporutnity to buy into emerging makets when they go down relative to developed international markets and vice versa?
Thanks,
Matt
@sleepydoc: I’m a bit confused about your question. The FTSE Canada All Cap Index is likely to be almost identical to the S&P/TSX Composite. So just think of VCN as a substitute for XIC or ZCN. If you’re using a 50/50 split of HXT and XMD to get a little more small-cap expsoure, the launch of VCN changes nothing for you.
@Matt: I would not wait around for a product that may or may not be launched in a year or so. Get the portfolio built right away, and if a Canadian version of VXUS eventually appears, you can always switch the next time you rebalance.
Hi Dan,
Can you please specify which investment account (non-registered, TFSA, or RRSP) is the most tax efficient for holding VUN?
Also, from the discussion so far, you mentioned that you prefer XEF over VDU. Is XEF the best available Canadian “equivalent” to VXUS? And what is the most tax efficient to hold XEF?
I’m likley going to continue holding VTI and VXUS in my USD RRSP, but moving forward, I would be willing to hold VUN and XEF (or a better VXUS equivalent) in whatever accounts are most tax efficient.
I appreciate the discussion so far and look forward to any future updates you will make to the Model Portfolios.
Thanks
@CCP:
Hi Dan,
You mentioned in the above comment that the FTSE Canada All Cap Index and the S&P/TSX Composite are very similar indexes – is there a site where one can look up the % breakdown of holdings by market cap? I was planning on buying ZCN and want to ensure that I still have the equivalent small/mid cap exposure if I were to switch to VCN.
Thanks muchly,
Frank
Also, in your eyes, is the capping on ZCN (using the S&P/TSX Capped Composite) worth the extra few basis points cost? I know, it’s probably just splitting hairs at this point.
@Hanson
https://canadiancouchpotato.com/2012/09/17/foreign-withholding-tax-explained/
https://canadiancouchpotato.com/2012/09/20/foreign-withholding-tax-which-fund-goes-where/
https://www.pwlcapital.com/en/Advisor/Toronto/Kathleen-Clough-Justin-Bender/Blog/Justin-Bender/May-2013/The-Good-the-Bad-and-the-Ugly-%28of-Asset-Locations
Since VUN holds the underlying US stocks, so it should fall under Group A, thus it’s better to have in your RRSP so that you won’t be affect by the foreign withholding tax. On a 2% yield and 15% withholding tax, you’re saving 0.3% a year. Of course you have to consider that everything within RRSP will have to be withdrawn as income, whereas if you invest in taxable account, the tax hit will be less since it’s capital gain.
Personally, I’m going to start buying VUN instead of VTI with future money. Too much hassle to do Norbert’s gambit and wait for my DLR to settle.
Does anyone know if a US Roth IRA can be transferred to a Canadian retirement plan or TFSA?
@Hanson: I’m concerned you’re putting the cart before the horse. Rather than asking which account type should hold VUN or XEF, the question should be which account type should hold US or international equities, and then the choice of product comes after that. And that question depends on your individual situation. Clearly it is always better to hold any asset class in an RRSP or TFSA compared with a non-registered account. So the answers to your question depend on your personal asset allocation and the amount of contribution room you have in your registered accounts.
XEF is probably the best single-fund substitute for VXUS, but it does not contain include emerging markets, so it’s not perfect. The closest you can get to VXUS with Canadian-listed funds is a combination of XEF and XEC.
@Frank: VCN and the FTSE Canada All Cap Index are still very new and the individual holdings have not been published yet—at least not as far as I can tell. Because both are cap-weighted and both cover the whole Canadian market, I would expect ZCN and VCN to be almost identical, and no, I would’t be in a hurry to sell one to buy the other.
@David L: I’m afraid your advice is not correct. VUN does not hold the stocks directly: VTI is its underlying holding, so it is actually in Group D on my list. Therefore it is not an ideal choice in an RRSP, because you would not be exempt from the US withholding tax. VTI is more tax-efficient in an RRSP, but again, there are all the other concerns we’ve been talking about (cost of converting currency, US estate tax issues, etc.).
@Al: This may help:
http://www.caringforclients.com/index.cfm?id=21788&modeX=BlogID&modeXval=9700&BlogID=9700
@CCP: Thanks for correcting that for me :-p Feeling embarrassed now for giving out wrong advice.
Hey Dan
Let’s say I’m maxed out on my RRSP with VTI and VXUS. Would topping up my non registered with VUN be a good way to rebalance my US contribution side?
@Chris: Impossible to answer that without knowing all the details. But in general, yes, VUN is probably a better choice than VTI in a non-registered account because you can trade in Canadian dollars and recover the withholding taxes.
very informative, to the point of overwhelming….. Now that we have diversity in our index funds – Canadian, US, international and being given more flexibility with the new Vanguard and Ishare funds this year, would you be able to put this information into a chart? It would be understood more clearly to confirm if we are putting new products into the right accounts – non registered, TFSA and registered.
Also, when you update your model portfolios, would you also show this in the form of a chart for the same reasons. It’s great that we are given more choices but it is now becoming more complex for a Couch Potato. Thanks Dan!
I agree with the request Claire made asking if the information about which funds are best in which type of account. It would be very helpful.
@Claire and TS: You’ve inspired me to write a whole post about this, but I’m afraid I can’t give you the answer you want. The most efficient asset location will vary from person to person: there is no way to boil down “which fund is best in which account” in a simple chart. You need to consider the big picture. I will elaborate in a future post.
For now I would urge you not to worry about too many small details, especially if the indecision is preventing you from implementing your investment plan.
@Claire and TS
I too had the same problems; there are a lot of variables, and you really need to find a way to summarize it in one chart or one table.
What I ended up doing is an Excel table that lists the total cost for every fund and every account. So for instance, the US equities part of my table looks like this (assuming 5% capital gains, 2% dividends, 40% marginal and rate, and that the recoverable taxes are recovered):
US equities
********** RRSP TFSA Taxable
Canadian ETFs that hold the stocks (TDB902) 0.65% 0.65% 2.14%
US ETFs (VTI) 0.25% 0.55% 2.05%
Canadian ETFs that hold US ETFs (VUN) 0.45% 0.45% 1.95%
These number represent the combine costs of the following components:
1- Capital gains
2- US witholdings rate on dividends
3- Canadian tax on dividends
4- US conversion fees (at 1.5% for conversion, it averages about 0.2% per year if you hold the fund for 20 years)
5- MER (TDB 902, VTI and VUN used for this example)
I think the only things missing are transactions fees and currency hedging.
Obviously in Excel, I’ve used formulas for everything, so I can change funds or assumptions if I want. Still, you get the idea.
Well, the formatting did not work too well. Just allow me to repost my example.
US equities
—————————————————————RRSP—-TFSA—-Taxable
Canadian ETFs that hold the stocks (TDB902)—– 0.65%—-0.65%— 2.14%
US ETFs (VTI)——————————————– 0.25%— 0.55%—2.05%
Canadian ETFs that hold US ETFs (VUN)———– 0.45%— 0.45%—1.95%
I’m glad we inspire our favorite couch potato teacher :-). I misled you to think that I am looking for one answer or simple chart for investing. Rather, I am looking for a way to help manage ETF information so I can make an informed decision. Probably a few charts addressing various investing scenarios would be helpful….
Dan, thanks again for your time by giving us your informative blog
@Sebastien: “You really need to find a way to summarize it in one chart or one table.” You are asking for hard-and-fast answers where they do not exist. The breakdown you provide has all kinds of assumptions that will not hold true for everyone, and maybe not even for you. For example, capital gains can be reduced through tax-loss harvesting, and no one is in the same marginal tax bracket throughout their investing career, and that will make a huge difference when comparing RRSPs vs TFSAs.
Look at how small the differences are in each category: often less than 20 bps. Change one of your assumptions slightly and you’d get a different result.
Investors need to accept that there isn’t always an easy answer their questions. They also need to recognize that it is very easy to make an elaborate calculation that seems precise but can lead you to the wrong answer if you ignore one factor or make one incorrect assumption.
Love to read your posts. Any insights on the other 2 new Vanguard ETFs: VGG & VGH?
Dan,
You mention that “in general, yes, VUN is probably a better choice than VTI in a non-registered account because you can trade in Canadian dollars and recover the withholding taxes”.
By using VDU instead of VEU, can you also recover withholding taxes in a non-registered account?
-Bruno
@JFCCP: If you’re looking for a US dividend ETF then VGG may be the best option: it’s well diversified, cheap and does not use currency hedging. Most of its competitors fail in least one of those measures. But I prefer total-market indexes to dividend funds, especially in a taxable account where foreign dividends are fully taxable.
@Bruno: In a taxable account, there is no difference between VDU and VEU. In both cases, international withholding taxes apply and are not recoverable, while US withholding taxes apply, but are recoverable.
Dan, I’d like to echo Park’s comments about tax reporting. You are in a position to put pressure on the Canadian ETF providers to do the paperwork required for the tax treatment of distributions on foreign funds to be passed through.
Dan,
Maybe there’s a good reason ETF providers don’t report tax information to recover withholding taxes and distinguish return of capital from foreign dividends. Why not investigate the subject in a future post?
Thanks for your awesome blog!
I mean ETF wrappers like VDU and VUN.
For me, new money will go to VUN, but will not touch my current VTI holding.
Hopeful Vanguard Canada would provide one for VXUS in the future.
I made the decision after reading carefully Dan’s posts and discussions related to this topic, and balanced it based on my own situation.
Thanks Dan!
@CCP
“They also need to recognize that it is very easy to make an elaborate calculation that seems precise but can lead you to the wrong answer if you ignore one factor or make one incorrect assumption.”
In a way, I certainly agree with you. My favorite example is currency conversion. How much does it cost? Well, using your spreadsheet, I found that it’s equivalent to about 300/70/35/20 bps if you hold the fund for 1/5/10/20 years. Sure depends a lot on the assumptions! And not just on how long you hold the fund, but also obviously on how much you’re actually paying for converting currency.
https://canadiancouchpotato.com/2010/10/18/are-us-listed-etfs-really-cheaper/
Yet, that being said, I still respectfully disagree with your conclusion. At the end of the day, you need to make a decision. That means that you have to try to account for all the variables, and find some way to weigh them against one another. I’ve found that the best way to do this is to make the best assumptions I can about my current and future situation, and then run through the calculations for the different cases. I then see what comes out, maybe do some sensitivity analysis on the assumptions, and then choose.
Imperfect? Sure. An “elaborate calculation” will indeed sometimes lead you to a wrong conclusion… but what’s the alternative?