For almost 20 years, the TD e-Series mutual funds have been one of the cheapest and easiest ways to build a Couch Potato portfolio. For most of that time they’ve gone about their business without much fuss, all the while outperforming the vast majority of their peers. But now there are some changes in the offing for these venerable old funds.

And don’t despair: the changes are mostly for the better.

If you hold any of TD’s e-Series index funds, you may have received a notice of these impending changes, and as a unitholder, you have the right to vote on them. In practice, though, they’re going to be approved whether or not you show up at the unitholder’s meeting in September. So let’s take a look at what’s going on and why.

New structure and new benchmark indexes

Several TD funds are undergoing changes, but we’ll focus on the four e-Series index funds that have long been part of the Couch Potato model portfolios:

e-Series FundFund CodeMER
TD Canadian Bond Index FundTDB9090.50%
TD Canadian Index FundTDB9000.33%
TD U.S. Index FundTDB9020.35%
TD International IndexTDB9110.50%

So, what’s new here? Rather than directly holding individual stocks and bonds, as they do now, these e-Series funds will instead use one of TD’s index ETFs as their underlying holdings. In other words, they will become a mutual fund “wrapper” for the ETFs.

Although they’re not well known, TD launched a family of index-tracking ETFs more than three years ago, and there are funds in each of the major asset classes. They’re comparable to the more popular offerings from Vanguard, iShares and BMO in my model portfolios, with competitive fees:

TD Canadian Aggregate Bond Index ETFTDB0.11%
TD Canadian Equity Index ETFTTP0.07%
TD U.S. Equity Index ETFTPU0.11%
TD International Equity Index ETFTPE0.20%

The above ETFs have very similar mandates to the TD e-Series funds, but they track different benchmark indexes. Since the e-Series funds will soon be using the ETFs as their underlying holdings, their benchmark indexes will change accordingly:

Asset ClassCurrent e-Series BenchmarkETF (and new e-Series) Benchmark
BondsFTSE Canada Universe Bond Solactive Broad Canadian Bond Universe
Canadian equitiesS&P/TSX Composite Solactive Canada Broad Market
US equitiesS&P 500Solactive U.S. Large Cap
International equitiesMSCI EAFESolactive GBS Developed Markets ex North America Large & Mid Cap

By way of background, fund companies pay licensing fees to their index providers, and the big names like S&P, MSCI and FTSE likely charge more than lesser-known competitors. So when TD launched its ETF lineup, they decided to team up with Solactive, a relatively new German firm that has also provided indexes for Horizons ETFs, Morningstar and other Canadian fund providers, presumably for a lower fee.

Will this make a difference to performance? It’s doubtful. So long as an index is designed to track a broad market using a traditional cap-weighted methodology, any differences are likely to be minimal. ETF investors should already understand this if they’ve chosen between funds in the same asset class from Vanguard, iShares and BMO, which generally use different index providers. Assuming the costs are the same, it’s hard to make a strong argument that any of these is inherently superior or inferior to the others. Have a look at the top holdings and the sector breakdowns in the e-Series funds and the corresponding ETFs and you’ll see they are nearly identical.

Never mind the theory: since we have three full years of performance for TD’s ETFs, we can see how the Solactive indexes have stood up to their competitors in practice. After adjusting for the fee difference between the e-Series and ETF versions, the Solactive indexes outperformed those of the e-Series funds in U.S. equities (+0.18% annualized) and international equities (+0.32%), and underperformed in Canadian equities (–0.35%) and bonds (–0.19%) during the three years ending July 31. So it’s been a coin flip, and the variations are likely random: there’s no reason to expect they’ll persist.

That said, any time a fund switches to a different benchmark index, that counts as “a change to the fundamental investment objectives,” and the fund provider needs to obtain the consent of a majority of unitholders. That’s why TD is reaching out to investors in the e-Series funds, and I’m not sure why anyone would vote against such a proposal.

Tax consequences

An important question to consider is whether there will be any tax consequences as a result of these changes. When the e-Series funds begin tracking different benchmarks, they will inevitably need to sell some stocks to bring their holdings in line with the new indexes. That could result in capital gains being realized and then passed along to unitholders using taxable accounts. (This is a non-issue if you use the TD e-Series funds in a TFSA or RRSP.)

But this is unlikely to be a problem. The e-Series funds will not need to liquidate their entire portfolios and then buy ETF units on the exchange. That would be what you or I would have to do, but institutional investors moving millions don’t need to do this. Instead, the mutual funds will package up their existing stocks in the same proportion as in the Solactive indexes. Then they’ll exchange those baskets of stocks for newly created units of the ETF. Perhaps it helps to think of this like exchanging 24 individual bottles of beer for a case of the same beer. No party is gaining or losing on the transaction, so this is not a taxable event.

Now, even after this in-kind exchange takes place, the e-Series portfolios will not precisely match their new benchmarks, so there may need to be some trading on the margins. According to the management circular, the estimated turnover in the four funds will range from 3.2% to 7.9%. In all four cases, the document says these trades “will be done in such a way, while using up any available tax loss carry forwards, to limit the tax impact to unitholders. This may take several years.”

What do they mean by “tax loss carry forwards”? Well-managed funds take advantage of tax-loss harvesting opportunities as they come up, and then carry forward those losses to offset future gains, which is why many index funds distribute almost no taxable gains to their unitholders. The 2018 financial statements for the TD Canadian Index Fund, for example, reveals $111 million in carried-forward losses, which means it’s unlikely to distribute gains any time soon.

For what it’s worth, RBC made a similar move in 2017, when they began using their own ETFs as the underlying holdings for their index mutual funds, switching benchmarks in the process. Their Canadian, US and international equity funds did not distribute any capital gains that year, though surprisingly their bond index fund did. (You probably shouldn’t be holding a traditional bond index fund in your non-registered account to begin with.)

If you’re wondering whether the structural change to the US and international e-Series funds will have an effect on foreign withholding taxes, the answer is no. When a Canadian mutual fund or ETF uses a US-listed ETF as its underlying holding, there can be an additional layer of foreign withholding taxes that applies even in TFSA and RRSP accounts. However, if the underlying holding is a Canadian ETF, this is not an issue: the foreign withholding taxes are the same as if the fund held the underlying stocks directly.

Lower fees

There’s more good news for e-Series unitholders. As part of the proposed changes, the e-Series funds will all enjoy a 0.05% reduction in fees. Note this table includes only the fund’s management fee. The full MER, which includes taxes, will be higher.

e-Series FundCurrent feeNew fee
TD Canadian Bond Index Fund0.45%0.40%
TD Canadian Index Fund0.30%0.25%
TD U.S. Index Fund0.35%0.30%
TD International Index0.45%0.40%

Five basis points isn’t going to allow you to retire earlier (it’s one latte a year on every $10,000 invested), but it’s a move in the right direction. With these fee reductions, a traditional balanced portfolio with 40% bonds and 20% in each of the three equity asset classes will see its MER dip below 0.40%, which is as cheap as an index mutual fund portfolio has ever been in Canada.

Wider availability

Finally, there’s been another big change to the e-Series funds that has gone largely unnoticed—partly because TD has done absolutely nothing to publicize it.

The biggest knock against the e-Series funds has always been that they played hard to get: you could only buy them in a TD Mutual Funds account (which you can open at a bank branch) or through TD Direct Investing, the bank’s online brokerage. Investors using other brokerages could only purchase the Investor Series (I-Series) versions, which have much higher fees.

But no more: the e-Series funds can now be purchased through other online brokerages. I can’t confirm that they’re universally available, but BMO InvestorLine, Scotia iTRADE and RBC Direct Investing have added them to the lineup. (If you’re able to confirm availability at other brokerages, please share this in the comments section.)

A little background on the reasons for this change. If you bought the I-Series funds through an online brokerage other then TD Direct, a significant part of your fee was a “trailing commission” paid to the brokerage. Trailing commissions are designed to compensate advisors for their ongoing advice, and they are still the way most mutual fund advisors are paid. But discount brokerages, by definition, cannot offer financial advice, and investor advocates have been arguing for years that it was unethical for them to collect these fees.

After facing pressure to stop this practice, TD sent a notice to investors who held their I-Series index funds through discount brokerages and told them their units would be automatically switched to the e-Series versions. This represented a significant fee reduction for anyone holding these funds, even if the investors didn’t notice. Going forward, DIY investors will not be able to buy I-Series funds at all: only the e-Series versions will be available.

For those who still appreciate the benefits of index mutual funds over ETFs, the TD e-Series offering just got a little better.