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Vanguard’s VXC Gets a Facelift

2017-12-02T22:29:04+00:00June 16th, 2015|Categories: ETFs, Indexes|Tags: |22 Comments

The Vanguard FTSE All-World ex Canada (VXC) allows Canadians to get access to US, international and emerging markets equities with a single ETF, and it’s one of the ingredients in my model portfolios. Vanguard recently announced some planned changes to VXC’s benchmark index, so let’s take a closer look.

Right now, VXC holds only large and mid-cap stocks, but it will soon be adding small-caps to the mix—at least for overseas markets. This will come about indirectly as a result of changes to the benchmark indexes of three of the fund’s underlying holdings.

VXC gets exposure to international developed and emerging markets through three US-listed ETFs: Vanguard FTSE Europe (VGK), Vanguard FTSE Pacific (VPL) and Vanguard FTSE Emerging Markets (VWO). These will soon begin tracking new “all cap” indexes that include small companies as well as large and mid-caps. Vanguard estimates that small-caps will eventually make up about 10% of each ETF. To reflect these changes, VXC will receive a new name: the Vanguard FTSE Global All Cap ex Canada Index ETF.

But it’s not clear whether VXC will add small-caps to its US equity exposure. The ETF currently tracks the US markets using the Vanguard Large Cap (VV). Given the fund’s new “all cap” mandate, I asked Vanguard whether VXC would be substituting the Vanguard Total Stock Market (VTI), which also includes mid and small-caps. The answer was no, though “over time we may consider alternatives that enable us to achieve exposure beyond what VV provides.”

There’s actually a good reason for this decision. Selling VV and buying VTI today could result in unitholders being slapped with a large capital gain distribution: VV makes up more than half of VXC, and it’s up about 28% (in Canadian dollars) over the last 12 months. Investors holding VXC in taxable accounts would pay a steep price for a switch to VTI.

With concerns like this in mind, Vanguard won’t be implementing the proposed changes all at once: the small caps will be added gradually over several months “to ensure an orderly and cost effective transition.” The changes are not expected to trigger capital gains, and there will be no changes to the funds’ management fees.

Canadians who use Vanguard’s other TSX-listed funds for international equities—both developed and emerging markets—will also be affected by these index changes: the Vanguard FTSE Developed ex North America (VDU), its currency-hedged counterpart VEF, and the Vanguard FTSE Emerging Markets (VEE) will be getting small-cap exposure, too. This will bring these ETFs close to their competitors, the iShares Core MSCI EAFE IMI (XEF) and iShares Core MSCI Emerging Markets IMI (XEC). The iShares ETFs already track “investable market indexes,” which is MSCI’s term for what FTSE calls an “all cap index.”

I see these changes as a positive development, for at least two reasons. First, small-cap stocks have historically delivered higher returns than large and mid-cap stocks in most countries. Second, funds that hold stocks of all sizes tend to have very little turnover, which means taxable capital gains distributions are less likely.



  1. William June 16, 2015 at 3:58 pm

    Good news certainly, but it will still be more expensive that iShares XAW… I would prefer th use Vanguard, but I honestly feel like VXC wasn’t well executed. Do you have any idea why they didn’t use VTI in the first place?

  2. Wali Le June 16, 2015 at 7:16 pm

    Shouldn’t the inclusion of A-Share be viewed as a concern? Given it’s impressive performance in recent years, the passive investors could end up holding the proverbial bag just in time for a market correction.

    Timing the market, perhaps. But it’s hard to argue the importance of timing in investing.

  3. Canadian Couch Potato June 16, 2015 at 8:47 pm

    @Wali Le: I’ll be discussing the addition of China A-shares in my next post.

  4. Linda Rocco June 16, 2015 at 9:58 pm

    It’s a good news but in the grand scheme of things, it will have a very limited impact on the overall return of most portfolios.

  5. Paul G June 17, 2015 at 1:06 pm

    I’d love to know how these changes could best be used to move away from VXUS to have ex-North America coverage that includes small caps, on American or Canadian exchanges.

  6. Morg June 17, 2015 at 4:08 pm

    so for someone who is thinking about adding VXC or XAW to his portfolio which one would you pick

  7. Henry Lee June 17, 2015 at 4:21 pm

    The changes that affect me in Vanguard’s proposal are with VDU (FTSE Developed ex-North America) and VEF (same ETF currency hedged). The changes will now add 8% Canadian equity to these ETFs. Vanguard says they will then create two new ETFs that are all-cap ex. North America. The intent of investing in VDU/VEF was to diversify my equity holdings outside the US and Canada and now they are adding Canadian equities back in. I think this is because these ETFs in turn hold US-based ETFs that are developed world ex-US so Canada is included. If I switch to the new ETFs, I need to incur transaction fees to buy and sell. Could they not have left VDU/VEF alone (or just add mid/small caps to it) and then create two new ETFs that included the developed world ex. US?

  8. Titi June 18, 2015 at 1:46 am

    Dan, VV actually covers both large and mid cap.

    VV (and the Large Cap Index) cover the top 85% of the USA market. The Small Cap index covers the bottom 85% to 2%. Therefore adding VB to VXC should do the trick.
    The bottom 2% is Micro Cap.

  9. Canadian Couch Potato June 18, 2015 at 9:23 am

    @Henry Lee: As you’ve anticipated, the addition of Canada to VDU/VEF was dictated by the changes to the underlying US-listed ETFs. The effect on Canadian investors is not top-of-mind when Vanguard makes chan ges to US-listed products. Vanguard Canada is making its own change to accommodate Canadian investors.

    I would not be concerned about the small allocation to Canada: it’s trivial in context of your overall portfolio. (This was always an issue with VXUS as well.) If it concerns you, you can always just lower your allocation to your Canadian equity ETF by a percentage point or two.

    @Titi: Thanks for clarifying. VV holds 649 companies with a median market cap of $75 billion, compared with the S&P 500, which has a median market cap of $80 billion. VTI holds 3,800 stocks with a median market cap of $51 billion. So the change in exposure would be significant.

  10. DMDave June 18, 2015 at 11:22 am

    The only reason why I will be sticking with VTI/VXUS for the moment and not switching to VXC is the diversification benefit with the former combo. Looking at website, VTI holds 3,824 stocks, and VXUS holds 5,888. Compare to VXC, which holds only 3,040 stocks. there is more diversification and exposure to small cap benefit, even if I subtract ~300 TSX stocks from VXUS.

    For the moment I use RY for Norbert’s Gambit when I have $5,000 or more to invest, so commission and buy/sell is really negligible. But when VXC approaches the diversification of VTI/VXUS, I’d be inclined to start using VXC just for the convenience it provides.

  11. Geo June 18, 2015 at 9:32 pm

    Any chance that one of the new ETF’s could be a Canadian listed VXUS like they did with VTI? I was very disappointed with VXC as it was all large cap American (well a little mid cap as mentioned above, so I stayed VXUS/VTI. I would likely pay the extra mer for the two funds being Canadian listed.

  12. Canadian Couch Potato June 18, 2015 at 10:14 pm

    @Geo: I don’t expect Vanguard to create a Canadian-listed version of VXUS. It’s really a fund designed for US investors, while VXC is designed for Canadians. You can always use VDU and VEE (or XEF and XEC) to get very close.

  13. Li June 19, 2015 at 8:56 am

    @Dan: I have to agree with Titi. I expect VXC to use VB to add U.S. small caps and match the new index without triggering capital gains.

  14. rob June 19, 2015 at 7:52 pm

    Is VXC cad hedged?

  15. Canadian Couch Potato June 20, 2015 at 10:05 am

    @rob: VXC is not hedged.

  16. Brian G July 9, 2015 at 2:02 am

    Why are they changing the mandate of existing funds?

    In their brief history, Vanguard Canada is developing a bit of a track record. First they churned when they swapped all their funds from MSCI indexes to FTSE and now this. I thought they were about simple passive investing with low portfolio turnover. However, it appears they can’t leave anything alone for very long and are generating their own portfolio turnover. Ugh.

    The last time I looked they had low MER’s but large bid-ask spreads and some tracking error issues. Hopefully, that’s solved but I haven’t looked recently and this news doesn’t have me wanting to look either.

    I’m impressed with how they run their US operation, but not so much with Canada.

    So far, Blackrock/iShares seems to have kept things simple and their fees have matched Vanguard. I also like how for the most part Backrock doesn’t change funds once they are created. For instance they kept the Claymore funds intact and they don’t tweak funds unless they have to (E.g. XTR.) This leads to seemingly very similar funds (e.g. XWD vs. XAW) but at least mandates don’t change under your feet.

    I guess competition is good and I get to choose and I chose the Blackrock (stable) way over the Vanguard (we know best) way. :)

    Also, XWD seems safer given it has no crazy “not really a free capital market” China stocks.

  17. cn_habs July 20, 2015 at 11:29 pm

    So XAW is officially superior to the new VXC because its management fee is 0.05% lower and has more underlying holdings? Thanks in advance.

  18. S. Johnston August 11, 2015 at 10:53 pm

    Unfortunately, it appears that not only will VEF now include Canadian stocks (in which most Canadians are probably over-weighted) but by going through a US-based ETF the dividend tax credit will be lost and higher taxes paid than if the Canadian stocks were held outside of VEF. So higher taxes and poorer global diversification for Canadians!

  19. Canadian Couch Potato August 12, 2015 at 9:02 am

    @S. Johnston: It’s true that VDU and VEF will move to an index that includes Canada, but this is a pretty minor change. If it’s a concern, you can always reduce your target for Canadian equities slightly to compensate.

    As for the loss of the dividend tax credit, this is not correct. Distributions from VEF have never been eligible for the dividend tax credit because all of the underlying stocks are foreign, and therefore all of the dividends have always been fully taxable.

  20. S. Johnston August 12, 2015 at 9:30 am

    But the Canadian stocks WOULD benefit from less tax on dividends if held individually or through a Canadian ETF whereas they WILL NOT in VDU and VEF. And though the percentage of Canadian stocks in these ETFs will be relatively small, I think it may still be significant when we’re talking of MERs of 0.20% (or 0.05% on some Canadian ETFs). I agree with you that “The effect on Canadian investors is not top-of-mind when Vanguard makes changes…”

  21. Canadian Couch Potato August 12, 2015 at 9:53 am

    @S. Johnston: OK, now I understand you were referring to only the Canadian stocks within the fund. You are correct, but the amounts would be so small as to be trivial. Canada is about 7.5% of the index, so if the fund has a yield of 3%, the Canadian portion would be 0.00225%. And this fund would probably represent only about 20% to 30% of a balanced portfolio. So it’s important to keep these things in perspective. It might be a cup of coffee a year.

    That said, a fund like iShares XEF may be preferable not only because it excludes Canada, but also because the stocks are held directly, reducing the impact of foreign withholding taxes. That’s a much bigger issue.

    I should also note that Vanguard has announced it will be launching a new FTSE Developed All Cap ex North America Index ETF, which will not include Canada. Not clear yet whether it will hold its stocks directly or via a US-listed ETF.

  22. Ken August 28, 2015 at 12:28 am

    Documents on show the new Vanguard FTSE Developed All Cap ex North America Index ETF will trade under the symbol VIU. The CAD-hedged version will trade under VI. The inception date for both ETFs is December 1, 2015. No information on holdings though.

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