iShares shook up the ETF marketplace last March when it launched its Core family of low-cost ETFs in the major asset classes. This week iShares announced some new additions to its Core lineup, including two broad-market funds that go head-to-head with recently launched ETFs from Vanguard. Let’s take a peek at these compelling new offerings.
Blanket coverage of the US
First up is the iShares Core S&P U.S. Total Market (XUU), which provides exposure to the broad US stock market, including large, mid and small cap stocks.
This is iShares’ answer to the Vanguard U.S. Total Market (VUN), and it comes in five basis points cheaper, with a management fee of just 0.10%. However, the coverage is not quite as complete: VUN holds more than 3,800 stocks, compared with 1,500 for XUU. Although XUU’s benchmark is the S&P Total Market Index (which includes almost 3,900 companies) the fund actually holds three US-listed ETFs that make up the S&P Composite 1500 Index. But we should keep this in perspective: the other 2,300 companies are so small that they collectively make up just 10% of the US market, so one should expect VUN and XUU to perform similarly.
One-stop global diversification
The iShares Core MSCI All Country World ex Canada (XAW) is a one-fund solution for adding global diversification to an equity portfolio, with broad coverage of the US, developed and emerging markets.
The counterpart here is the Vanguard FTSE All-World ex Canada (VXC), launched last June and recently added to my model ETF portfolios. In this case, the new iShares ETF actually offers broader coverage: it holds about 5,000 stocks, compared with just over 3,000 for VXC. Again, the management fee is five basis points lower at just 0.20%.
XAW holds five underlying funds: it gets US exposure through the three ETFs that make up the S&P Composite 1500; it gets European and Asian developed markets through the iShares Core MSCI EAFE IMI (XEF); and it covers emerging markets through the iShares Core MSCI Emerging Markets (IEMG).
This ETF does not use currency hedging, so Canadian investors will be exposed to a basket of foreign currencies: primarily the US dollar (just over half of the fund), the British pound, the yen and the euro.
Should I switch?
I’ll try (probably unsuccessfully) to head off the questions I always get whenever new ETFs are launched with lower fees: “Are you going to update your model portfolios with these new funds?” and “If I already own VUN or VXC, should I sell them and buy these new ones?”
The answer to both questions is no, at least for now. These new iShares offerings look like excellent products, and if you’re building a portfolio from scratch I would have no hesitation recommending them as alternatives to the Vanguard ETFs in my model portfolios. (The same is true of the iShares and BMO Canadian equity ETFs, which are perfectly good alternatives to VCN.) The difference it will make to your long-term performance is likely to be trivial. And it makes no sense to incur trading commissions and bid-ask spreads to save 0.05% a year in management fees. Remember, that’s $5 on a $10,000 investment.
However, if you already hold one of the Vanguard ETFs, these new funds may be useful for tax-loss selling. This strategy works best when you can find two ETFs that get very similar market exposure while tracking different indexes. There really were no ETFs that made good substitutes for VUN and VXC until now. One of these days, when we actually see significant losses in US or international equities—that hasn’t happened since 2011, not that we’re complaining—one could harvest a loss in VUN and purchase XUU in its place, or sell VXC and replace it with XAW.
Not sure if it’s the case here, but how do you compare the fees between an ETF that holds the actual stocks versus one that holds other ETFs?
There seems to be a new trend this year for funds of funds (ETFs of ETFs?) to charge next to 0. That would simplify the calculation!
@fluffy: When an ETF holds other ETFs instead of buying all the stocks directly, it can benefit from economies of scale. Imagine, for example, the transaction costs involved in buying all 5,000 stocks in a fund like XAW. When iShares and Vanguard do this, the management fee in the underlying ETFs are rebated, so investors are not double-charged.
The big difference has to do with foreign withholding taxes, which are affected by the fund-of-fund structure:
https://canadiancouchpotato.com/2014/02/20/the-true-cost-of-foreign-withholding-taxes/
I knew about scale and taxes, it’s the rebate part that puzzles me. I always assumed that the management fee of the underlying security had to be paid. Where does it say that it’s rebated?
Keep up the good work!
@fluffy: ETFs are not permitted to double-dip on fees:
http://www.theglobeandmail.com/globe-investor/investment-ideas/is-my-etf-double-dipping-on-fund-fees/article4182696/
This is also explained in the prospectus in the section entitled “Summary of Fees and Expenses.”
http://www.blackrock.com/ca/individual/en/literature/prospectus/prospectus-feb-04-2015-en-ca.pdf
I’m wondering if there is any benefit to XAW over VXC FWT-wise since one of the underlying funds is a Canadian listed ETF that holds stocks directly (XEF)? Would that portion of the fund be claimable? Or is the FWT lost regardless of the underlying ETF as soon as you get into this fund of funds realm?
Thanks!
@Scotty: In theory, yes, XAW would be slightly more tax-efficient because XEF holds its stocks directly. But I expect the benefit would be quite small, and measuring this accurately would be pretty time-consuming. :)
I placed a limit order for XAW this morning even though there was no volume or much other info listed, did I make a mistake buying a fund so new?
It doesn’t even seemt o be updating in google finance!
I was curious to understand what XAW held as its assets, to see how it would line up with my % allocations for US and international markets. Based on current holdings, it is:
US – 53.66%
Developed international – 35.27%
Emerging markets – 10.73%
That’s pretty easy to calculate for now, however, what’s not clear is if the asset allocation % will remain the same (or close to) in the future? In other words, I didn’t see any targets on the website and therefore is it possible that the US portion could balloon up to 70%? Or will they maintain the approximate current ratios, within some kind of tolerance band?
I currently hold XUS with the intention that at some point I would add a smaller cap US ETF to broaden my US exposure. Seeing as you have simplified your model portfolios, would you suggest continuing with that plan, or switching out to XUU/VUS. Or standing pat with XUS alone? Thanks
Thanks for the update on these new ETFs – you’re one of the very few writers who provides this kind of news without any bias or spin. Please keep up the great work!
Curious that XAW holds XEF and IEMG instead of XEF and XEC. Any thoughts on why they made this choice and what the difference is between IEMG and XEC?
@Steven.PP: Personally I wouldn’t place a large order for a day-old ETF unless I had reliable Level 2 quotes. Hope you used a limit order!
@Jeremy: XAW weights each country according to market capitalization, so if the US were to eventually grow to 70% of the global equity market I expect the fund would do so also. (These numbers will indeed change. Not too long ago emerging markets made up about 15% of the global market, but that share has fallen significantly.)
@Colin: I would not be in a huge hurry to switch, but next time you rebalance it may be worth moving to a more broad-based ETF rather than limiting yourself to the S&P 500, which is only about 70% of the US market.
@#Dan D: Thanks for the comment. XEF holds its stocks directly, but XEC simply holds IEMG. So it doesn’t make sense for XAW to hold XEC when it can just hold IEMG directly.
Thanks for the news about new funds.
Now we have two choices which are pretty much the same thing:
VCN+VXC+VAB
XIC+XAW+XBB
Sooo….waiting for BMO’s move then I presume?
Good Evening,
Does anybody know if there is an ishares equivalent to VXUS?
I like the idea of separating the US form the rest of the world in my portfolio. That’s why I havn’t switched to VXC (my only problem is that vxus is 6% Canadian, so I have to take that into account in my Canadian allocation).
Thank you.
Sophia
@CCP:
About these “wrap” ETFs, which contains multiple ETFs inside, do they suffer from the same problem than other canadian ETF regarding “hidden” re-invested capital gain distributions, which make ACB tracking much more complicated than it should be?
Thanks!
@Sophia: There is no Canadian equivalent to VXUS. The closest you can get is combining two ETFs that track developed and emerging markets, such as XEF and XEC. Regarding the 6% allocation to Canada in VXUS, this is a trivial amount and I would not worry about adjusting your Canadian allocation to compensate.
@Jas: I don’t see any reason why the wrap structure would complicate ACB tracking. All distributions (cash and reinvested) are paid out and reported the same was as traditional ETFs.
I wonder if this XUU.TO ETF will prompt Vanguard Canada to drop its MER on VUN.TO to match the MER of 0.10%? That would be excellent. Also, does VUN.TO hold individual securities directly or is a fund of funds?
@SNB: VUN holds an underlying ETF, not the individual stocks. (Note that this has no impact on its tax-efficiency.)
For someone who was going to add VCN to my TFSA and VXC to my RRSP maybe I should add XAW instead around 20$ range compared to the 30$ for VAC?
@Morg:
Notwithstanding that Vanguard Canada is a profit centre for Vanguard US, I have a lot more confidence in Vanguard’s commitment to low cost ETFs than I do in BlackRock’s. The .05 MER difference between VXC and XAW is too small to care about, and it is in any event likely to shrink as either BlackRock raises or Vanguard lowers. With Vanguard, you don’t need to worry about stealth MER increases if and as market conditions permit.
That said, I do like the fact that XAW seems to reach deeper than does VXC into the small-mid cap space. It’s this feature, rather than the lower MER, that is giving me pause.
I hold VXC. I will continue to do so and await developments.
VXC was already having be take a hard look at consolidating my US/INT holdings, but XAW makes that decision pretty easy.
@Scotty (and Dan): I wouldn’t say that the difference in tax efficiency between XAW and VXC is too trivial. If developed markets yield 2% and make up 35% of the index, and US withholding tax (level 2 in this case) is 15%, then VXC is paying an extra 0.35*0.02*0.15=0.00105 (10.5 basis points) in tax. Assuming the indices tracked by VXC and XAW perform the same (also assuming that my math is correct), XAW would beat VXC by 15.5 basis points. Not necessarily worth paying a commission to switch, but the difference is somewhat significant.
Lots of folks on this blog are quoting Vanguard Management Fees as if they are the Management Expense Ratios. I have yet to see Vanguard actually publish an MER for any of their Canadian products. Despite using them in my wife’s RRSP, I find that somewhat disingenuous, and I have told them so, without a response.
@Matt: The withholding tax on EAFE stocks is generally less than 15%: we estimate it at about 10% or so. But even if you do save 10 basis points on withholding taxes, the fund is likely to make up only about 20% of a balanced portfolio, which means the savings is 0.02% on the overall portfolio. This may be significant to some: I just like to put these things in perspective so people resist the urge to tinker with their portfolios every time a new product comes out.
@Rob: Vanguard’s website prominently includes both the management fee and full MER for most of its ETFs. For example:
https://www.vanguardcanada.ca/individual/etfs/etfs-detail-overview.htm?portId=9557
Any ETF with less than a calendar year of history or that has changed its fee within the last year (both of which may apply to Vanguard ETFs) will not publish its MER, since it will not be known yet. That will follow eventually. In the meantime, you can get a reasonable estimate of the MER by adding 10% to account for taxes: for example, 0.20% becomes 0.22%.
@Dan: I was talking about the US withholding tax (level 2). If I understand correctly, both VXC and XAW have to pay the international withholding taxes, but only VXC pays level 2 tax (on international developed stocks). You are definitely right about the tinkering though, to save $20 in a year with 10 basis points you would need to hold $20k of VXC (or $100k in a balanced portfolio), and $20 isn’t worth the hassle of switching. Vanguard may eventually match the MER anyways!
@Matt, US listed ETFs pay less level 1 tax than Canadian counterparts. Roughly 6-7% vs 10-13% here so simply discounting the 15% US level 2 withholding overestimates the effect.
so for someone who is not in either and wants to put 10k into one of them would it not make sense to put it in XAW at 20$ and get more units then at 30$ I expect the returns will be roughly the same for both ETFs?
@Morg: Sorry I did not answer your previous comment: I wasn’t sure what you meant, but now I understand.
The unit price of an ETF tells you virtually nothing. It’s like saying this restaurant charges $2 for a slice of pizza and that one charges $3. Unless you know how large the slices are, the comparison is meaningless. It reminds me of the Yogi Berra joke where the waitress asks if he wants his pizza cut into six or eight slices, and he says, “You’d better make it six. I’m not hungry enough to eat eight.”
Imagine an ETF tracking a global equity index has $100 million in assets. It might have 5 million outstanding shares, which would mean a net asset value (NAV) of $20 per share. Now imagine a second ETF tracking the same (or similar) index has $150 million in assets. It might also slice that pie into 5 million shares, in which case the NAV per share would be $30.
If you had $10,000 to invest, you could buy 500 shares of the first ETF or 333 shares of the second. Both would have an identical value and there is no reason to prefer one over the other.
@gsp: That’s interesting I’ve never thought about that. So the US has different (better) tax treaties with other countries than Canada?
@Matt, I have no direct knowledge of the treaties involved but would assume so based on the withholding rates reported by funds on either side of the border.
Justin and Dan showed this in their Foreign Withholding Taxes white paper. https://www.pwlcapital.com/pwl/media/pwl-media/PDF-files/Justin%20Bender%20Assets/PWL_Bender-Bortolotti_Foreign-Withholding-Taxes_v04_hyperlinked.pdf?ext=.pdf
Bogleheads displays tax info on US listed Vanguard funds. We can determine the level 1 tax they pay by simply looking at the foreign tax credit Americans can claim for holding these funds. Here’s VEA’s tax info, pay attention to Table 2: http://www.bogleheads.org/wiki/Vanguard_Developed_Markets_Index_Fund_(VDVIX)_tax_distributions
It remains to be seen how much foreign withholding taxes XEF and ZEA will pay once their direct holdings are reflected in annual reports.
Dan,
Choosing to buy XAW or VXC instead of buying the underlying ETFs does not allow one to rebalance if, say, the EAFE markets have a particularly good year while the US market fails to do as well. Do you think there is much benefit lost in not being able to rebalance annually between individual USA, EAFE and emerging markets ETFs?
BB
@BB
Interesting question, and I’m interested in Dan’s response.
My thought is that not being able to rebalance among the constituents of VXC is a good thing, not a bad thing. VXC embraces cap weighted index investing, whereas rebalancing among constituents distorts it.
There are good reasons to rebalance between fixed income and equity (risk control) and good reasons to rebalance between domestic equity and non-domestic equity (matching currency of assets and currency of liabilities). But I’ve never understood the merits of rebalancing among various non-domestic equity markets. There’s nothing “natural” about or “inevitable” about a 30-30-40 allocation among Japan-Europe-US, just as there’s nothing “natural” or “inevitable” about it being 10-30-60 instead. There’s no reason to think there will in the long run be a reversion to one of these allocations instead of some other one altogether. Without a reason to believe in reversion of some kind there’s no reason to rebalance.
But I’m probably missing something! I look forward to Dan’s comments.
@BB and KISS: I don’t think the decision is likely to make a big difference one way or the other. Like KISS, I agree that it makes sense to begin with the idea that your foreign equities should be roughly cap-weighted, and for a long time the US has made up roughly half of the global equity market. So a simple 50% US, 50% international (including emerging markets) was a good approximation. If you wanted to drop emerging markets, well, 50% US and 50% EAFE was fine, too. Remember, asset allocation is not a chemical formula: the mix does not need to be precise.
As for the rebalancing bonus you might get if you held the individual components of VXC, this would show up in some years and work against you in others. Overall I’m not sure it offers enough expected benefit to make a strong argument against a one-fund solution like VXC or XAW.
Newbie-level question (again): Can I buy Vanguard or iShares from within my TD Webbroker account, or can I buy only the eSeries from within my Webbroker account?
i.e., Currently I have all my cash in TD Webbroker. Vanguard Canadian Aggregate Bond shows up in its dropdown menu for purchasing, but doesn’t seem to allow me to go further than that. Would I need to set up a Vanguard account, and move money into that, in order to go the Vanguard ETF (Model Portfolio Option #3) route? (And ditto iShares, as above?)
@Tara: You can buy any ETF from any discount brokerage. But it sounds like you may have signed up for TD’s “Basic RSP,” which allows you to by mutual funds and GICs but not ETFs or stocks. I would suggest calling TD to clarify.
@Dan and KISS: Thanks for the advice. What you’ve said makes a lot of sense and I’ve decided to go with XAW at my next rebalancing.
@Dan: I’ve read your site intermittently over the years, but have only recently come to realise the value in this blog. I’m in the midst of going through all old articles. I do have one other question about rebalancing. Years ago when I first read about “couch potato” investing in MoneySense, I seem to recall an article talking about taking into account the 3-year moving average of the stock market when rebalancing. What I remember reading was a suggestion that we use bands for our equity-bond allocation and tend towards one end of that band or the other depending on how the return on the stock market over the prior 3 years compared with the overall long-term stock market return. For instance, one might choose a balanced 60/40 equity/bond split, but allow for a 10% band on either end. When rebalancing, the advice as I recall it, was to compare the 3-year moving average of the markets with the long-run average and, if the 3-year average is below the long-run average, increase your equity portion to 70%. Likewise, if the markets had been outperforming the long-run average over the last 3 years, the advice was to decrease stock exposure, say to 50%. Does that advice ring a bell to you? Does it make any sense in your opinion?
Just noticed the fact sheet for XUU on the Blackrock website lists a total of 3896 holdings. It looks like they might hold micro-cap companies individually.
Looking at the underlying holdings for XUU.TO, as expected for a fund of funds it holds U.S.-domiciled ETFs like IVV and the small and medium cap ETFs. But XUU.TO also directly holds individual stocks in companies like Tesla, amongst others. What is the purpose of holding only a very small number of stocks directly in addition to larger ETFs? Also, do you anticipate that XUU.TO or a similar Canadian-domiciled ETF of U.S. securities will buy up the underlying individual securities like what XEF.TO did for EAFE securities in order to allow for recovery of foreign withholding taxes?
@BB and SNB: I spoke to the folks at iShares to clarify these issues as well. The have made a decision to track the S&P Total Market Index (which has over 3,800 stocks) but they will do so by holding three ETFs that collectively hold 1,500 stocks. By tweaking the weighting of these three funds, as well as adding some individual stocks, they believe they can closely track the Total Market Index. I would describe this is as representative sampling, and I think it’s a bit of a risk on their part, because it could result in high tracking error.
With XUU there is no advantage to holding US stocks directly rather than via a US-listed ETF: the withholding tax implications are the same. The “fund of fund” structure is only an issue with international equities.
@BB: Regarding rebalancing using moving averages, you wouldn’t have read that on my site. Here are my thoughts on rebalancing thresholds:
https://canadiancouchpotato.com/2011/02/24/how-often-should-you-rebalance/
It’d be a good practice to resume looking at MER as “MER per quarter century” or whatever.
When you expect your fund to only get you 5% long term, a higher MER by 0.05% isn’t helpfully summarized as $5 per $10,000, it’s “1% of my growth rate, forever”. So it literally IS worth it long term (which is all we are ever talking about at CCP) to eat $20 in fees and some spread for a 0.05% MER gain.
is there a disadvantage to splitting your purchase to 50% XAW and 50% VXC ?
@Morg: The only disadvantage is redundancy and maybe a few extra trading commissions. There’s no real harm in holding two funds that are essentially the same, but no benefit either.
In an answer above you say that the fact that VUN holds an ETF and not stocks directory “has no impact on its tax-efficiency.” Elsewhere on this site (https://canadiancouchpotato.com/2013/08/16/inside-the-new-vanguard-etfs/) you mentioned that VUN is less efficient than VTI in an RRSP since VTI is not subject to withholding taxes. Do I misunderstand or are these statement contradictory? Or has something changed since the previous post?
@Frank: The difference here is that VUN is Canadian-listed and VTI is US-listed. The fact that VUN does not holds its stocks directly is not a factor.
I am interested in XAW
So you buy it in canadian dollars. Are the distributions paid out in canadian dollars, or US dollars?
I want to see if it needs to be held in the US side of my account.
Thanks
@Bill: XAW will pay distributions in Canadian dollars and would be held on the CAD side of your account.
Just a bit of topic but does anyone subscribe to Globe & Mail Unlimited yesterday Larry Macdonald wrote about his One Minute Portfolio where he has two ETFs that covers his needs and it only takes him one minute every year to pick just wondering if its any we have been talking about. I don’t subscribe so I cant see which ones he’s talking about?
Going back to an older post here but hopefully I can get a response. When comparing Vanguard vs. iShares ETFs should I factor whether a fund is DRIP eligible into my decision making process? I am with RBC Direct Investing and none of the Vanguard funds (VAB, VCN, VXC) are currently DRIP eligible. Given that these funds seem somewhat interchangable with XQB, XIC and XAW (XQB & XIC are DRIP eligible, XAW is not) and I pay $9.95 per transaction it seems like DRIP eligibility should matter. I realize there will still be trading fees when it comes to rebalancing but I only plan to do that once per year. In the case of VCN vs. XIC where dividends are paid quarterly (or VAB vs. XQB monthly) would it be beneficial to choose funds that are DRIP eligible to ensure those funds are invested as soon as possible without trading fees?
@Tyler: In my opinion, DRIPs offer some convenience, but they are pretty irrelevant in the big scheme of things. My colleague Justin Bender recently illustrated this with an example:
http://www.canadianportfoliomanagerblog.com/the-drip-myth/
In an RRSP, when holding XUU, is this a typical Canadian ETF that holds US securities, for which US withholding tax applies and is not recoverable? …. or …is it like the XEF model (discussed here https://canadiancouchpotato.com/2014/09/12/foreign-withholding-taxes-in-international-equity-etfs/) where US withholding taxes no longer applies?
I am debating whether to purchase XUU in my CDN$ RRSP, or to look instead for a US listed ETF to hold in my US$ RRSP.
For completeness, a seperate question is this: If XUU were held in a taxable account, is it correct that US withholding tax applies, but can be recovered?