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.
@Sebastien: When the difference between two options is likely to be small and the calculations likely to be inaccurate, it is reasonable to choose whichever option is the easiest.
If you’re willing to make all of these calculations on your own, I won’t try to discourage you. My concern is that the vast majority of people are not inclined to build a spreadsheet like the one you describe, and I don’t want them to feel overwhelmed by decisions like this. I want to encourage them to simply pick one good option, even if it is not the optimal one.
Vanguard funds seem appealing because of the low MER but when I last looked at many of them, the bid-ask spread was still large and they often trade above their NAV. These new funds will be worse for quite some time until volume picks up. I would like to switch to Vanguard from iShares but right now, they are not competitive in terms of liquidity. Pity.
I am surprised nobody has brought this up yet. (Or did I just miss it?)
The liquidity of an ETF is determined by its underlying assets – the stocks it holds. A Canadian S&P cap weighted top 60 ETF with 90 billion dollars has the same liquidity as a Canadian S&P cap weighted top 60 ETF with 1 million dollars. This is because in an ETF, the units are created and deleted when when you buy and sell the ETF. If a stock is liquid ex. Royal Bank of Canada, it will be liquid no matter how much money is in the actual ETF itself. Most index providers run analysis to make sure they only include liquid stocks in their indexes.
One scenario where you need to worry about the amount of money invested in an ETF is to ensure it will exist in the future. An ETF that only gathers 1 million dollars over a ten year period might not be profitable to run in the long run and thus might close, making you sell your shares, triggering capital gains in your account. With the core ETFs in a big company like Vanguard, the chances of these ETFs shutting down is slim to none.
As for why bid-ask spreads are different from their NAV, it has to do with how complicated it is to calculate up to the second NAVs with so many underlying stocks moving in so many directions all at once. Sometimes the NAV might be listed above or below the bid-ask, but if you actually were to put in a market order, you’ll see that it automatically adjusts and your order will fill at market price.
@Brian and Matt: I’m not sure I buy that “it has to do with how complicated it is to calculate up to the second NAVs with so many underlying stocks moving in so many directions all at once,” but the larger point is generally true. Namely, trading volume and assets under management don’t have a meaningful impact on an ETF’s liquidity. As I’ve discussed before, however, low volume can cause some confusion around pricing, and even around reported returns:
https://canadiancouchpotato.com/2012/09/10/etf-liquidity-and-trading-volume/
https://canadiancouchpotato.com/2012/09/13/an-etf-pricing-puzzle/
https://canadiancouchpotato.com/2013/03/13/two-ways-to-measure-an-etfs-performance/
For a long-term investor who is not making frequent trades, it really should not be a significant issue.
@Matt @CCP, maybe I phrased my concern wrong by using the term liquidity. My main concern is the bid/ask spread and price/NAV spread. You can tell me that this isn’t a problem of liquidity… but it is a problem. Just compare the spreads of any comparable pair of iShares and Vanguard ETFs. E.g. XSP/VSP, XBB/VAB, etc. The Vanguard spreads are always larger and sometimes significantly so.
One can be a long term investor and still do frequent trades. For instance, when one is doing regular purchases (e.g. monthly RRSP contributions) as you can now do for free at Questrade then the spreads do matter. I estimate about 0.1% to 0.4% depending on the funds and your timing/luck.
I forgot to mention my main point… the larger bid/ask spread and price/NAV spread can easily wipe out the MER advantage at the time of purchase.
@Brian “One can be a long term investor and still do frequent trades.”
The frequency of the purchases has no impact on the cost in your no commission scenario. What matters is how long the security is held. A 3 cent spread will cost you half that on your purchase or roughly 4 basis points at VG Canada’s roughly $25 pricing on most ETFs. Over a 20 year holding period that becomes a whole lot of nothing(.2% of a basis point).
The largest spread I can recall seeing on a VG CA ETF was 9 cents. That’s 18 basis points of spread cost on a purchase. You’re right that it needs to be factored in to which product you choose to hold, especially when considering a switch. If you are saving 5 basis points per year vs Ishares it will only become worth it to purchase the VG product in this example by halfway through the 4th year and that’s before factoring in the Ishares exit cost(and commission on sale).
As mentioned in one of CCP’s linked articles, if you notice a wide spread on an ETF you’d like to purchase, contact the ETF provider and share your concern. They’ll crack their whip if a market maker isn’t doing his job properly. I did when I saw the 9 cent spreads mentioned above and lo and behold the spread magically shrunk to 5 cents the next day and stayed there going forward.
For long term investors spread costs are amortized over extended holding periods, MERs grind away at your portfolio year after year.
@gsp “The largest spread I can recall seeing on a VG CA ETF was 9 cents.” … yep, and it’s still that way. Right now (12:51 EST) the bid/ask spread for VAB is 24.13/24.23 (10 bips) for XBB it is 29.88/29.89 (1 bip) I doubt that it is a coincidence that we see 10 bips show up again… it seems systematic.
“contact the ETF provider and share your concern” I’m sure someone at Vanguard is reading this. Consider my concern shared.
The price/NAV spread also behaves weirdly if you watch it closely. At any given time compare VAB or XBB’s current market price to the respective previous day’s closing NAV to see for yourself. I have noticed that the premium on VAB is usually higher. Also, on the few days I watched it very closely, I noticed what I believed closing of this spread in the last few minutes of trading.
Anyway, call me pedantic but I just have a rule of not trading anything with a bid/ask spread bigger than it’s peers because I know behind that lurks something I don’t understand or know about but I do know someone is pocketing the difference and it’s not me.
On the above message where it says “bips” I should have wrote “cents”. Oops… I was going to do the bips calculation but I forgot to go back and do that before I pressed submit. :)
@Brian, my memory is clearly failing me. :(
Went back to check my records and the spread on VAB shortly after inception was an obscene 16 cents(63 basis points, over 3 times the annual management fee). After contacting them it was reduced to 8 or 9 cents(can’t recall exactly).
Sorry to hear it was back up to 10 cents when you checked today. Half that is roughly 21 basis points or 3 year’s worth of lower MERs(.26% vs .33%).
I also noticed the weird price moves vs NAV and used it to my advantage to purchase below NAV. There are worse things for the patient aware investor.
I agree they should work with market makers to reduce this ETF’s spread(and any others that may get that high). Anything above 5 cents(.1% each way) seems excessive. Hopefully as VG keeps gathering assets and volume this issue disappears.
Hello,
I’m a Canadian resident and a long-time reader of your blog. I have a small business with income that is derived primarily from the United States. As a result, the vast majority of the cheques that I receive are in U.S. currency.
In my corporate investment account, I’m invested in:
Vanguard Total Stock Market ETF (VTI)
Vanguard Total International Stock ETF (VXUS)
In my TFSA, I’m invested in:
FTSE Canada Index ETF (VCE)
In my RRSP, I’m invested in:
Vanguard REIT ETF (VNQ)
– Do you think I should be trading in VTI and VXUS for their CAD equivalents?
– What do you think of my portfolio set-up from a tax perspective?
Thanks
@Michael: I can’t give you tax advice, but in terms of trading, I don’t see any advantage to switching out of VTI and VXUS if you are receiving US-dollar income and using it to purchase these funds. The main obstacle for Canadians using US-listed ETFs is expensive currency conversion, but in your case that doesn’t seem to be an issue.
If you are holding foreign equity ETFs in corporate account, you will want to read this post by Justin Bender:
http://www.pwlcapital.com/en/Advisor/Toronto/Kathleen-Clough-Justin-Bender/Blog/Justin-Bender/February-2013/Foreign-Withholding-Taxes-in-a-CCPC
Trying to incorporate some of the new Vanguard ETF’s into our Complete Couch Potato portfolio without trading on the US exchange and dealing with currency exchange. We will utilize the Vanguard VUN in lieu of VTI. For the International and Emerging Markets Equity would Vanguard VDU be another option instead of Vanguard VXUS? Any suggestions?
@Rob: There is no single-fund substitute for VXUS, which includes both developed and emerging markets. VDU includes only developed markets, so if you want complete coverage you would also need to use an emerging markets ETF such as VEE or XEC:
https://canadiancouchpotato.com/2013/04/15/new-ishares-etfs-give-canadians-the-world/
Hi CCP,
I have a retirement portfolio inspired by your Complete Couch Potato model portfolio. I’m in a bit of a pickle regarding purchasing VTI and VXUS since they require USD. Since I’m with Questrade my buys are free, so I contribute to all my CAD funds as soon as I have the cash available, but this is more complicated with VTI and VXUS. I would like to accumulate at least 10K before gambiting funds to USD, but in the mean time I want to put that money to good use. I was thinking that I could purchase VUN (Vanguard U.S. Total Market) and VDU (Vanguard FTSE Developed ex North America) and when I reach a value of 10K for both, sell, gambit, and purchase VTI and VXUS. This will incur 3 sells (1 each for selling VUN and VDU, another for the USD gambit sell). I know all these fees rack up and it could be a wash in the end. Earning returns on up to 10K aren’t likely going to break the bank, but I guess you never know what could happen. What do you recommend for the average couch potato to do with funds earmarked for VTI and VXUS in their portfolios?
@Sean: By the time you add up the commissions, the loss on the bid-ask spreads and the currency conversion costs (Norbert’s gambit is cheap, but not free) you may find it’s not worth all the effort: as you say, it may end up being a wash. You may find it makes most sense to just use the Canadian-listed funds until you have an amount much larger than $10,000. Maybe you can do a gambit every two or three years when you were planning to rebalance anyway.
Hi CCP,
I’m having a hard time with no data choosing VUN. I’ve been looking at purchasing VTI, however with it’s lofty price and my RRSP at CIBC (which has no US$ RRSP account), I’ve been cautiously watching for a minor dip to buy.
But is there a way to tell what the dividend distribution will be like? What the Bid/Ask spread will be for VUN?
I just want to make sure I don’t buy a product that actually performs similar to VTI without a huge tracking error.
@Rick: I don’t imagine the tracking error will be huge, though there will be some gap for sure. You can check the bid-ask spread any time: right now it seems to be about 3 cents, or about 0.12%. With VTI, it’s only a penny and the share prices is much higher, so the spread is virtually zero.
The dividend distribution on VUN should be the same as for VTI, minus the withholding taxes. The yield on VTI us currently about 2%.
There’s no question there will be some drag with VUN, but the trade-off is you avoid trading in USD, which can be extremely expensive if you don’t take steps to reduce the cost.
@Rick. If you go to your favorite financial website (I used tmxmoney) and plot VUS vs. VTI:US (adjust for splits and dividends) you’ll see that even with CAD hedging overhead there is no tracking error between the Canadian and US products and they perform identically.
If you go to Vanguard Canada’s own site, click on the product, then Prices and Distributions. There you’ll find the trailing 12 month yield and a premium/discount chart which will answer your Bid/Ask vs. NAV question.
I’ve found that all Canadian ETF company sites are full of very good information; best to look there first.
Hi! CCP,
I have about $20,000 that I plan on investing in a selection of Vanguard ETFS. I plan
on making my choices from the 13 Canadian offerings. The one thing holding me back
is whether to go hedged or unhedged. Vanguard seems to have both for many of their
funds. Under what circumstances would it be better for a given investor to purchase
either one. I do not want to make any mistakes . Which would you choose?
Thanks,
Ross
@Ross: My first comment would be that if $20K is the whole portfolio, ETFs are not likely to be a cost-effective choice. This is a topic I’ve written about at length.
https://canadiancouchpotato.com/2012/07/30/comparing-the-costs-of-index-funds-and-etfs/
https://canadiancouchpotato.com/2013/09/12/the-one-fund-solution/
All of my model portfolios use unhedged ETFs. While hedging will help if the Canadian dollar rises in value during a prolonged, it tends to cause a long-term drag on returns.
https://canadiancouchpotato.com/2010/10/29/to-hedge-or-not-to-hedge/
My recommended ETFs are listed here:
https://canadiancouchpotato.com/recommended-etfs/
Hello again CCP,
Thanks for the quick response. While I do have $20,000, I have another $10-15,000
that I have the option of bringing into play also. I will start with $20,000 first. As I
have the money currently in a discount brokerage ( Virtual ), the aspect of high com-
missions is not a significant problem. I have within my TFSA two accounts : one in
$CAN, the other in $US. The CAN account is free, while the US costs $50 annually.
The problem of conversion costs will be limited.
I took the time ( a couple of hours ) to read through the blog topics you suggested.
The information was very informative. Thanks. From the information in your
response, I take it you believe that ” unhedged” is the way to go in the long-term
( to avoid the drag on returns ). Given the information above and the fact that I ex-
pect to make few initial trades ( perhaps 100-200 shares each of VCN,VUN,VDU, and
VEE, as well as some of VSB or VSC, does your recommendation still stand?. I will
not be needing this money in the short to medium term and I do follow the markets.
Thanks again,
Ross
@Ross: If you’re paying no account fees and no trading commissions, then the ETF option certifiably becomes more attractive. It’s hard to go wrong with the Vanguard ETFs you’ve mentioned. Just keep things simple in the beginning and use a plan you’ll stick to with discipline.
Hi CCP,
I did not say that I am paying no commissions; just that they relatively low ( 200 shares
for $2.00, 100 shares for $ 1.00, etc., up to a maximum of $9.99. ). This is for most
shares over than or equal to $1.00. Please see http://www.virtualbrokers.com for further de-
tails.
Also, of the new Vanguard ETFS, you did not mention VGG/VGH. I would like to know what your thoughts are on these, relative to the others mentioned.
Thanks,
Ross
@Ross: Virtual Brokers offers commission-free purchases of all ETFs.
My preference is always for total-market index ETFs, not dividend-focused strategies.
Hi CCP,
I bit the bullet on Friday and purchased 200 shares each of VUN, VDU, VEE, and VSC, through Virtual Brokers. With reference to your previous entry, I reviewed
the process of purchasing ETFS based on their main heading of free trading and
believed you to be correct. To my surprise, I got charged a commission of $2.00
for each trade ( total $8.00 ). It seems the free trading of ETFS only applies to a
select list. After speaking with a Virtual rep., he told me while the heading does say
all ETFS, that I had to read the small print at the bottom of this list. I found this
” all ETFS ” heading to be very deceptive.
I also mistakenly purchased these shares at market price. I checked the ” Bid/Ask ”
spread and since it was not significantly far off decided to buy theses shares at what
I expected would be the asking price. Well the order was filled immediately at prices
between $0.05 and $0.17 higher than what I was expecting. The VB rep. told me
that these prices fluctuate from moment to moment. I am still skeptical and out approximately $80.00 more than anticipated.
I take this experience as a lesson learned and will always use limit orders in the future. I am delaying buying VCN until I have a little more money, but also because I have 10 shares each of 6 Canadian blue chips that I bought in the spring while I was exper-
imenting. Let me know what you think.
Thanks,
Ross
P.S. I noticed your association with Moneysense, I took out a subscription this
summer. Its a good magazine.
@Ross: Sorry to hear the trading experience did not go well. The Virtual Brokers offer is confusing, but my understanding is that all ETFs are free to purchase. Regular trading commissions will apply when you sell, however, except on a select list of funds. That much is explained here:
https://www.virtualbrokers.com/contents.aspx?page_id=10
I have never used VB, but I have heard that you need to sign up for one of their pricing programs: “The 99,” “Free ETFs,” “Per Trade,” etc. At the top of the Commissions and Fees page it says, “At Virtual Brokers you have flexibility to choose the commission structure based on your trading profile. Please click on the following tabs to see your options.” So you may need to call customer service and clear that up before placing future trades.
Yes, you should always trade ETFs with limit orders to avoid surprises. But you should also understand that you’re not really out $80. The orders were filled at the current market price: had you placed a limit order below the market price, it just would not have been filled.
@Ross: Thanks for the feedback on the VirtualBrokers “free ETF” offer. Everytime I start wanting to move my accounts to VirtualBrokers or Questrade to lower my 9.95$ commissions, I start thinking about the sustainability of their business model and I get worried, so I do nothing. As I can see, VirtualBrokers still have some fees on their free ETFs. As for Questrade, when I read their website, I learn about weird fees, such as ECN fees. I guess I’m not ready yet to move my accounts to these brokers.
To keep my transaction fees low enough to justify using ETFs over mutual funds, I deposit new investment money (on payday) into a savings account at an online bank (http://www.highinterestsavings.ca/chart/) until I have enough to make a transaction.
I like your choice of ETFs. My portfolio is exclusively composed of Vanguard Canada ETFs. I have been very happy, so far, of their index tracking and low fees.
Hi Ross,
With respect to the comments above about placing an a limit order instead of a market order, is this something that should be done all the time or only with ETFs that have low liquidity?
I went “all into” the market about 8 months ago with my life savings (a large amount by most standards) and did not place any limit order. I also never use limit orders when I reinvest the dividends.
However, the ETFs that I invest in are VTI, VXUS, VNQ, and VCE. The first three ETFs have billions in net assets; given their high liquidity, I do not expect that a limit order would have saved me much.
With limit orders, you also run the risk of the stock price going up and the order not being filled, which means there is potential for it to cost you more in the end. There seems to be different schools of thought on this topic, but I can see why it makes sense for thinly traded ETFs.
I’m interested in hearing your thoughts…
@Michael: You should always use limit orders with ETFs, regardless of the ETF’s trading volume. There’s only one school of thought on this issue: every ETF provider urges investors to use limit orders.
With our DIY clients, we recommend placing a buy order two to four cents above the ask price; for a sell order, set the limit two to four cents below the bid. If the order is not filled right away, it’s because the quoted price was not accurate. If that happens, you can adjust the limit order by a couple of cents and do it again.
As I explained to Ross, the order will get filled at the same price whether you use a market order or a limit order. The difference is that the limit order will eliminate surprises—and as he discovered, the surprises can be large.