[Note: This blog post was updated several hours after it was published, as new information became available.]
The Vanguard Total International Stock ETF (VXUS) has long been part of my Complete Couch Potato portfolio, since it gives instant access to virtually all the world’s markets outside the United States. I’m frequently asked whether Vanguard is planning to launch a Canadian-listed version of VXUS, so investors could avoid the expense and hassle of converting their loonies to US dollars. The answer is probably no—but the solution might be even better.
Vanguard Canada announced today that it will launch five new ETFs later this year, the most interesting of which is the Vanguard FTSE All-World ex Canada. While full details have not been published yet, the preliminary prospectus explains the fund will track “the performance of a broad global equity index that focuses on developed and emerging markets, excluding Canada.” The management fee has been set at 0.25%.
This new ETF is not a Canadian wrapper for VXUS: it will include US stocks and exclude Canada, whereas VXUS does the opposite. But in many ways that’s even more convenient for Couch Potato investors who want to keep their holdings to a minimum. The fund can be combined with a Canadian equity ETF to get exposure to the whole world with just two funds instead of three or four.
The benchmark is the FTSE All-World ex Canada Index, which was newly created for this product: FTSE provided me with this hot-off-the-presses fact sheet. The index includes almost 2,900 stocks in 46 countries.
Vanguard is not able to discuss the details of the ETF because we’re in the 90-day waiting period that follows the release of the preliminary prospectus, so we can only speculate about its structure. It will almost certainly hold a combination of US-listed ETFs, but it’s not clear which ones. A blend of 50% Vanguard Large-Cap (VV), 40% Vanguard FTSE Developed Markets (VEA) and 10% Vanguard FTSE Emerging Markets (VWO) would roughly match the global market capitalization outside Canada and the number of stocks in the new index. But VV does not track a FTSE index, and I’m not sure whether Vanguard would include it in a fund pegged to a FTSE benchmark. We’ll just have to wait and see.
Global bonds here at last
Two other new ETFs are designed to add global exposure to the fixed income side of your portfolio. The Vanguard U.S. Aggregate Bond (CAD-hedged) will hold the US-listed Vanguard Total Bond Market (BND), while the Vanguard Global ex-U.S. Aggregate Bond (CAD-hedged) will be a Canadian wrap for the Vanguard Total International Bond (BNDX), except that it will be hedged to the Canadian dollar instead of the greenback. Its largest holdings are in Japan, France and Germany.
These ETFs were actually announced last June, and as I wrote at the time, I don’t view foreign bonds as a core holding for the average investor. But they might be appropriate for conservative portfolios with a high allocation to fixed income: exposure to the US and international bond markets would add some diversification, since interest rates in various countries do not move in lockstep. Foreign bonds should be currency hedged, so using US-listed ETFs isn’t a good option and these new Vanguard funds plug that gap in the market. (All other foreign fixed-income ETFs in Canada cover corporate, high-yield or emerging market bonds only.)
Rounding out the list of new ETFs are the self-explanatory Vanguard FTSE Developed Europe and Vanguard FTSE Developed Asia Pacific. I don’t see either of these as a significant offering for Couch Potato investors, since you can already get both markets with a single fund. They will be useful only for investors who want to get tactical by overweighting one or the other.
don’t get me wrong, I love vanguard and own lots of their funds where its appropriate. Something about all these new international wrapper etfs is leaving a bad taste in my mouth. I guess the bond ones may find a place in my taxable account one day but all I can see in the rest is layers and layers of international and US withholding taxes being lost. I was really hoping they would come out with something that can actually compete with ZEA in my registered accounts.
If I understand your explanations of withholding taxes on dividends, if you hold this new Vanguard FTSE All-World ex Canada ETF in an RRSP, you’d lose out on the 15% withholding tax on the portion of the ETF holding U.S. dividends. Whereas, with VT or VTI, you wouldn’t be hit with this withholding tax. Is that right?
If the Vanguard FTSE All-World ex Canada ETF invest in “primarily large- and mid-capitalization stocks,” i don’t see how it could hold VTI, since VTI also own small capitalization stocks. Or maybe this is what Vanguard mean by “primarily”…
@Michael James, my understanding of the tax implication of “wrap ETF” is similar to yours. DFA have a lice little whitepaper on this confusing issue :
https://canadiancouchpotato.com/wp-content/uploads/2012/09/DFA-Foreign-Withholding-Taxes.pdf
@PWT and Michael James: Yes, in an RRSP you would lose both levels of withholding tax (US and international). Remember, though, that in an RRSP you always lose the lose international portion, no matter which ETF you hold (ZEA and VT do not solve this problem). If you hold this new ETF in a taxable account, the US portion of the withholding tax would be recoverable, but the international portion would be lost. In this case, ZEA would be more tax-efficient.
This is all about trade-offs. For many investors there would be significant savings with a product like this simply because it avoids currency conversion and minimizes trading costs by reducing three holdings (e.g. VUN, VDU and VEE) to just one. While it would be nice to see a global equity ETF that held all the stocks directly, this would require enormous scale that simply doesn’t exist in Canada. ZEA and ZDM are still using representative sampling and holding less than half the stocks in the MSCI EAFE index.
@Michel: With all due respect to DFA, our own white paper on this subject goes much further:
https://canadiancouchpotato.com/2014/02/20/the-true-cost-of-foreign-withholding-taxes/
At the same at as iShares dropped its pricing on XEF and XEC, they also announced a change in investment strategy allowing them to hold stocks directly. If ZEA and ZDM (with over $800M) are not holding the full index, do you think there’s any chance of XEF and XEC actually following through, given that their indexes have even more holdings?
It’s interesting that just as these products start to become available, the need for them seems to be decreasing at the same time. As noted, the potential advantages here are less trades (but trade costs have been and still are in a general decline, with some brokers even offering free transactions on some or all ETFs) and ability to avoid currency conversion (which thanks to declining costs, better user interfaces, broker competition, and websites/guides like this, is also becoming less intimidating). I’m sure these will be useful to some folks, no doubt.
I think Vanguard needs to be congratulated. Not for bringing these new ETF’s to market now, but for waking the competition from their greedy slumber years ago. Look at us now, instead of being milked for high MER’s at every turn we are left bickering over the scraps of taxes on dividends and broker trade commissions. Thanks Vanguard we owe you a million!
@pwt, i share your opinion. As a small investor i have the sentiment that Vanguard interests are much more aligned to mine than, lets say BMO.
If there was a Vanguard and a BMO funds with identical holding and the Vanguard one had a MER a couple bp higher than BMO, i would still go with the Vanguard fund (ex VCN vs. ZCN).
TD e-series might be the exception to the rule but i try to stay away from big banks when i can.
Yay for Vanguard !
I will be very tempted to replace my VDU, VEE, and VUN holdings with this new All-World ex Canada ETF. This would simplify my portfolio.
I agree with the other posters: Yay for Vanguard! And, thanks to Dan for keeping us informed of new products for passive investors.
Vanguard started first index fund in USA, alas, they are not issuing any index fund in Canada.
You got to wonder if they’ll every provide couch potato-esque complete ETFs (a one-fund solution). I hold an ING fund because it is easy. If Vanguard (or one of their competitors) could just package up their holdings into a single fund it’d be really nice.
@ CCP:
“Rounding out the list of new ETFs are the self-explanatory Vanguard FTSE Developed Europe and Vanguard FTSE Developed Asia Pacific. I don’t see either of these as a significant offering for Couch Potato investors, since you can already get both markets with a single fund. They will be useful only for investors who want to get tactical by overweighting one or the other.”
Well … I wouldn’t go that far. There is a potential rebalancing bonus to be had in separating an investment primarily located in the EU and mostly denominated in EUR and GBP, from one in the Pacific Rim and mostly in JPY and AUD.
The EAFE index originated 40 years ago as a quick and dirty way for US investors to get international equity exposure, at a time when few did and when the US market was by far the largest part of world market capitalization – so lumping “the rest of the world” (as it then was and ignoring Canada) into a single index was reasonable.
The rationale for combining such a diverse group of regions, economies and currencies into a single index is a lot weaker today: international investing is easy and the market cap of EAFE (or its FTSE equivalent) is now roughly equal to the US (the MSCI “Emerging Markets” index is equally arbitrary – highly developed and technologically advanced South Korea lumped together with vastly underdeveloped India and hydrocarbon-dependent Russia? – and in fact MSCI and FTSE can’t even agree if South Korea is “Developed” (FTSE) or “Emerging Market” (MSCI) …)
I suppose for many Couch Potato investors all this just makes a great case for a single Global Equity ex Canada fund, like the new Vanguard offering. But there has to be a reasonable case for separating Developed Markets equity exposure, at least between Europe – Pacific Rim, that goes beyond a futile exercise in tactical over- and under-weighting.
(For the record, we also use the bizarre 40 year old EAFE/ Emerging Markets index allocations)
Is there any research on how currency exposure affects bond volatility from a Canadian perspective? Since the US dollar is typically considered a safe currency, would it be possible that US bonds could be less correlated with the stock markets than Canadian bonds?
@Richard: I’m not aware of any specific research on this idea. The research I have read on hedging does indeed suggest that the US dollar has some negative correlation with the equity markets, which is why unhedged exposure is a benefit for Canadians. So you raise an interesting point: a Canadian holding US-denominated bonds might get an added boost in a market downturn, since both the bonds and the currency might be expected to appreciate. However, overall I would expect the portfolio to be much more volatile. Better to keep your fixed income safe and steady and get that currency exposure on the equity side.
@Steve: Fair enough: there is a potential rebalancing benefit from splitting Europe and Asia. But once you go down that road you can make arguments for splitting government and corporate bonds, large and small caps, value and growth, individual countries, etc. With international equities I think it’s perfectly reasonable to simply hold all countries in roughly equal weight to their market cap. Half US and half international (for example, VTI and VXUS) does that pretty well and keeps the portfolio very easy to manage. A single ETF covering the whole world outside Canada is even more efficient and eliminates the labeling issue you mention (i.e. developed versus emerging).
@ CCP:
Yep, agreed – and the new Vanguard global equity ex Canada fund you describe looks to be a good Couch Potato option.
I actually think there is another reason, in addition to simplicity/ efficiency, to favour solutions using the fewest funds possible for most investors: psychology. There is no point setting up one’s portfolio to capture a possible rebalancing bonus if one cannot execute the rebalancing plan – and many investors seem to have trouble executing precisely when rebalancing is the most useful. It’s not easy selling “winners” to buy “losers” in the teeth of a market crash!
I’ve been a DIY indexer for almost 15 years, and having continued rebalancing normally as per our plan through the Dotcom bubble bust and the Financial crisis – as well as the TSX run-up last decade and the US market this one – I’m fairly confident I can capture any rebalancing bonus available through our uncomplicated asset allocation. But I always encourage others to consider as simple a Couch Potato style portfolio as possible, in part to reduce the risk of “rebalancing freeze” at the worst times. The new Vanguard global equity fund could be a great tool to that end.
@Dan: From what I am gathering, VTI in a RRSP would still have a better bottom line if the size of the holding was large enough, and Norbert’s gambit was always used? Are you going to do another post once this ETF is trading?
What do you think of doing another cost analysis post? What with all the variations that a Canadian can choose from when building their portfolio, you would think that you can mathematically show the thresholds where one variation would be significantly better than another. I imagine steps, for example, people starting out could begin at Tangerine (former ING), stay there until they reach dollar lever of ??? And DIY confidence level, then move into an all Canadian ETF portfolio, and then likewise once they reach the next levels, branch out to US ETFs. What do you think?
@Que: If you assume an investor is using Norbert’s gambit (or some other method to convert currency cheaply) then VTI is certainly going to be cheaper than a Canadian-listed alternative in an RRSP, since the MER will be lower than the withholding tax will be exempt. So there’s nothing new here.
It’s tempting to do a cost analysis of the different options, but my concern is this would just make the decision even more difficult. I don;t know how to put a price on convenience and confidence levels, for example. These aren’t math decisions: they’re personal. I’ve worked with several people who use e-Series funds and Canadian-listed ETFs in large portfolios: these are slightly more expensive, but that’s not the only factor to consider.
@Steve remember that funds like this don’t actually rebalance, their weights just drift with the market. They’re still a useful tool for all the reasons that CCP listed but to get automatic rebalancing you need a balanced fund that intentionally does it.
Is the Vanguard FTSE All-World ex Canada ETF then similar to XWD except as a cheaper alternative and better diversified? Will this mean the demise of XWD?
@Harvey: XWD includes Canada and excludes emerging markets, so they won’t be the same. XWD may still have a place, but it’s getting pretty expensive compared with the alternatives.
@Dan: I believe that if there were a cost analysis available to see the comparison, it would come down to personal choice, in terms of how much convenience is worth.
I tried to do some rough calculations, and I feel happy saving lots of money by doing more work for my retirement portfolio, and contrary by enjoying the simpler more convenient but more expensive (percentage wise) in my child’s RESP portfolio. Actually made the decision less difficult.
Therefore, I strongly believe that having a cost analysis is very critical in helping anyone decide and feel comfortable at finding that balance between cost and convenience.
@Richard:
Yes, I know that the new Vanguard fund doesn’t rebalance its internal asset class weights. My point was just that the trade off between simplicity vs rebalancing opportunities in portfolio construction may be a false debate for many investors: they would be best served by ignoring potential rebalancing options (by dividing international equity exposure across multiple funds, for example) that they might find difficult to take advantage of in the crunch in any case.
@CCP:
Do you think this new fund will eventually be included in your list of suggested model portfolios?
@Jas: It would probably be a great choice in the Global Couch Potato, since it would reduce the holdings to just three funds and would add emerging markets as well.
@CCP: In fact one third each of VCN/the new Vanguard All-World ex Canada/VAB could be the Canadian version of Bill Bernstein’s portfolio in his new book “If You Can”. No currency conversion needed, and a company where the fund owners are the shareholders.
Indeed a good case could be made to stay with just those 3 ETFs with large portfolios, adjusting asset allocation as needed – the Canadian version of the Bogleheads 3 fund portfolio.
CCP, do you know if Vanguard has any plans for an developed markets value ETF, or developed markets small cap value? Is there any reason they haven’t yet?
@Jon: I don’t have any insight into Vanguard’s plans for future product launches. I think value and small-cap ETFs are a reasonable expectation, but I don’t know anything specific.
I have quite a bit in a US account meaning that using an all world ex-Canada would be doubling up on many holdings unless I wanted to spend the price of currency conversation to bring it all back into Canada. I like the idea of only having two equity funds to cover the world- but not sure the currency conversation and the slightly higher overall MER is worth it.
33% XIC, 33% Ex-Canada World, 33% XBB, would be a breeze to manage.
Tempting…
Ant time frame for the ability to buy these ETF’s yet?
@Brian: The new ETFs will begin trading July 8.
Thank you so much for all you do. I have been poring over your site trying to prepare for my first ever couch potato investments, and I have a few questions. Any help would be greatly appreciated!
My situation is a bit unique as I am a non-resident of Canada (citizen, but living abroad). I do not pay capital gains tax but am subject to 15% dividend-withholding tax. I have just opened a TDWaterhouse non-resident account, however, due to non-residency status I cannot buy e-series funds.
I am 29 years old, considering this allocation (slight millionaire teacher influence in here too):
29% Canadian Bond Index ETF – HBB vs. VSB
25% Canadian Stock Index ETF – HXT vs. VCN
23% US Stock Index ETF – HXS vs. VUN
23% International Stock Index ETF – VDU
1. I am struggling with deciding which ETFs to buy, even though I know you say not to agonize over it! Mainly, I am puzzled by Horizon’s swap-based ETFs, and curious if their tax efficiency puts them ahead of Vanguard in your opinion? (I know there are risks associated with bank bankruptcies, although I am inclined to think this is not a big risk as Canadian banks seem stable.)
2. How do we know how much the “dividend” given back into Horizon’s funds actually represents? I have been trying to calculate it to find out how much savings I might be looking at if I go with them, but have been unsuccessful.
3. I am charged $9.99 a trade and am wondering how often you would recommend I invest, especially as I only have $20,000 to start with. Should I invest everything at once, or stager it slightly (ie. start with 10,000 and invest the rest quarterly)? I could also wire money from overseas a couple times a year, at an extra 10$/time…
4. If I own 4 funds (as above), would you recommend investing into the fund with the lowest % every couple months to keep the trading fees low, and then doing a more thorough rebalancing at the end of each year?
5. Should I be considering VXC in my case (ie. due to the fees associated with having so many funds)?
Thank you in advance. You rock,
C
@Chantal: Glad you’re enjoying the site. You haven’t said where you are currently living, and I’m hesitant to offer any advice to any non-resident Canadian because tax laws and investment options vary widely.
In general, with a $20,000 account I think your focus should be on keeping things simple and easy to manage. Your suggestion for using VXC instead of separate ETFs for US and international equities is a good one, for example. I would not suggest worrying about dollar-cost averaging: investing lump sums will be less costly, especially if you need to wire money from overseas each time. You can do a little rebalancing with every lump sum.
As for assessing the tax advantage of HBB, you’ll want to consider the “average coupon” of the alternative. This is the amount of interest paid to you in cash, all of which is fully taxable. For VAB it’s currently 3.7%, so on a holding of $5,800 (29% of $20K) that works out to about $214 in interest. HBB, on the other hand, pays no interest and any growth would be considered a capital gain.
Hi Dan, thanks for your quick reply! I am living in the UAE – as far as you know, does what I wrote in my previous post sound correct (with respect to taxes)?
Incorporating suggestions, my portfolio might now look like this:
29% Canadian Bond Index ETF – HBB
25% Canadian Stock Index ETF – HXT (MER 0.07% + 0.01%) vs. VCN (MER 0.13%) ?
46% US & Intl Stock Index ETF – VXC (Does this increase to 46% make sense?)
I should be able to contribute 30,000-35,000 a year to investments from now on. Once I pass the threshold, where the transaction costs make more sense, should I consider buying the individual ETFs instead of VXC?
Ok, does that mean that the average coupon of bonds is given back as interest (taxable, at 15%?) like a dividend? In the case you outline in your above post, I assume this would mean a savings of 15% of $214, or $32/year?
For my Canadian Stock ETF, I am still torn between HXT and VCN. I have been reading articles and the risk of the Horizon funds seems to fall primarily on the following three things: any decisions to change tax laws, the funds not surviving long term, and counter-party risk. HXT would save me about 15$ of tax this year, and it looks like the MER also makes it a favourite. Is there anything else I am not considering when comparing these two?
Thank you!
@Chantal: I’m afraid I can’t get more specific without crossing the line into giving you investment advice.
Regarding the interest from a bond fund, it is fully taxable at your marginal rate (which is probably higher than 15%). If an investor held $10,000 worth of a bond fund with a coupon of 3.7% it would pay $370 in annual interest. If that investor’s marginal tax rate is 30%, then she would pay $111 in tax that year. If the same investor held $10,000 in HBB they would receive no interest and pay no tax. However, the value of the fund would increase and the investor would then be responsible for paying any capital gains when the shares of the ETF are eventually sold.
The difference between VCN and HXT is similar.
Thank you very much. I appreciate the example :).
I understand that when holding international securities via a US-listed ETF, you’re not exposed to the CAD/USD rate — only the currency of the underlying holding.
I’m wondering about the hedging for the global ex-US bond fund, though. Since there is usually a cost associated with hedging (it doesn’t work perfectly), and BNDX hedges the international exposure (to USD) and then Vanguard Canada hedges the USD exposure for the Canadian ETF… is the unintended hedging cost doubled? Or does the cost in the USD-CAD hedge “cancel” the cost in the international-USD hedge, so that the hedge cost would be the same as holding and hedging the foreign bonds directly (ignoring withholding tax issues)?
Thanks.
As Steve said, “re-balancing paralysis” is a real thing. It’s not easy to sell the winners and buy the losers. But then keeping things simple with just 3 ETFs isn’t going to be an easy choice for a finicky DUI :)