So, what did you think of the Game of Thrones grand finale??? I don’t want to spoil it for both of you who haven’t watched it yet, so I won’t share my own thoughts here. DM me if you’re interested.
In the meantime, let’s embark on our own epic wrap on our “Under the Hood Series” about Global Equity ETFs. In today’s final quest for the global equity crown, we’ll conclude with two Vanguard ETFs that track FTSE Russell indices.
- Part I: Two Canadian-listed and U.S.-listed global equity ETFs from iShares that track the MSCI World Index (XWD and URTH) (found here)
- Part II: Two iShares global equity ETFs that include both developed and emerging market stocks (ACWI and XAW) (found here)
- Part III: Two Vanguard global equity ETFs tracking FTSE Russell indices (VT and VXC)
VT vs. ACWI: You’ve Got the Whole World in Your ETF
The Vanguard Total World Stock ETF (VT) is the complete package. It currently includes about 8,000 large-, mid-, and small-cap stocks in emerging and developed markets (including Canada). The number of holdings is set to increase further, when its underlying index provider, FTSE Russell, begins adding China A shares to its global equity index line-up this year.
Out of all the global equity ETFs we’ve reviewed, VT is most comparable to the iShares MSCI ACWI ETF (ACWI). The MSCI ACWI Index (which ACWI tracks) allocates about 88% to companies in developed markets and 12% to emerging markets companies, while the FTSE Global All Cap Index (which VT follows) has a similar breakdown – at least it does after the region weights have been adjusted for index country classification differences for Korean and Polish companies.
Sources: FTSE Russell and MSCI Index Fact Sheets as of December 31, 2018
The main differences between the two ETFs are:
- VT includes small-cap stocks, while ACWI only includes large- and mid-cap companies.
- VT has annual expenses of 0.10%, while ACWI will run you 0.31%, or about triple the cost.
Both VT and ACWI are U.S.-listed global equity ETFs, so they have similar foreign withholding tax implications across all account types. As VT is cheaper and more diversified than ACWI, most investors would likely prefer investing in the former.
Estimated Unrecoverable Foreign Withholding Taxes: VT vs. ACWI
Account Type | VT | ACWI |
---|---|---|
Registered Retirement Savings Plan (RRSP) | 0.12% | 0.15% |
Registered Retirement Income Fund (RRIF) | 0.12% | 0.15% |
Locked-in Retirement Account (LIRA) | 0.12% | 0.15% |
Life Income Fund (LIF) | 0.12% | 0.15% |
Tax-Free Savings Account (TFSA) | 0.49% | 0.50% |
Registered Education Savings Plan (RESP) | 0.49% | 0.50% |
Registered Disability Savings Plan (RDSP) | 0.49% | 0.50% |
Taxable Accounts | 0.12% | 0.15% |
Sources: BlackRock Inc., The Vanguard Group Inc., MSCI, FTSE Russell, as of December 31, 2018
VXC vs. XAW: A Day Late and a Tax Dollar Short
Last up, the Vanguard FTSE Global All Cap ex Canada Index ETF (VXC). VXC is a direct competitor to the iShares Core MSCI All Country World ex Canada Index ETF (XAW). As the “ex Canada” in their names suggest, both VXC and XAW exclude Canadian companies. VXC has a cost of 0.27% per year, while XAW comes in slightly lower, at around 0.22%.
VXC tracks the performance of the FTSE Global All Cap ex Canada China A Inclusion Index. “China A Inclusion” in the name indicates the index includes over 1,900 China A shares, but these companies only account for around 0.43% of the index. Although XAW’s index, the MSCI ACWI ex Canada IMI Index, does not specifically mention China A shares, it does include a small allocation of 0.08% to large-cap China A shares. This amount is expected to increase in 2019 as MSCI increases its global equity allocation to China A shares.
As “All Cap” and “IMI” are included in the names of the FTSE Russell and MSCI indexes tracked by VXC and XAW, we know both funds include large-, mid- and small-cap companies. After the region weights have been adjusted for index country classification differences for Korean and Polish companies, we find that both indices have nearly identical weights allocated to U.S., international, and emerging markets companies.
Sources: FTSE Russell and MSCI Index Fact Sheets as of December 31, 2018
Both indices have also returned 11% on average over the past 10 years, as of December 31, 2018.
Sources: MSCI, FTSE Russell, Morningstar Direct as of December 31, 2018
Keeping VXC Under Wraps
VXC uses a fund-of-funds, or wrap structure, to gain exposure to around 9,500 stocks from developed and emerging markets. This is similar to XAW, which tracks around 8,400 stocks.
For emerging markets exposure, VXC simply holds Vanguard’s U.S.-listed fund, the Vanguard FTSE Emerging Markets ETF (VWO).
For U.S. stocks, Vanguard has chosen to hold two of its existing ETFs in order to mimic the returns of the FTSE USA All Cap Index:
- VV – a U.S.-listed ETF that follows the CRSP US Large Cap Index, and
- VB – a U.S.-listed ETF that follows the CRSP US Small Cap Index
Vanguard could have opted for a single U.S. equity fund, the Vanguard Total Stock Market ETF (VTI), which follows the CRSP US Total Market Index. However, because VTI’s underlying index includes a small allocation to micro cap stocks (while the FTSE USA All Cap Index does not), Vanguard felt the two-ETF approach would result in less tracking error relative to the target index.
When VXC was launched in 2014, Vanguard had yet to create a Canadian-listed international equity ETF that held the underlying stocks directly. Instead, Vanguard chose to hold two existing U.S.-listed ETFs to gain exposure to international stocks: The Vanguard FTSE Europe ETF (VGK) and the Vanguard FTSE Pacific ETF (VPL).
Holding VGK and VPL for international equity exposure created two challenges for VXC investors.
Challenge #1: Taxable Tribulations
First, as the international equity ETFs are U.S.-listed (and a Canadian-listed ETF holds them), this causes an additional layer of foreign withholding taxes across all account types, relative to holding a Canadian-listed international equity ETF that holds the underlying stocks directly.
The impact of VXC’s relatively tax-inefficient structure can best be illustrated by comparing the foreign withholding tax drag for VXC vs. XAW. Across all account types, VXC has higher unrecoverable foreign withholding taxes than XAW.
Estimated Unrecoverable Foreign Withholding Taxes: VXC vs. XAW
Account Type | VXC | XAW |
---|---|---|
Registered Retirement Savings Plan (RRSP) | 0.48% | 0.36% |
Registered Retirement Income Fund (RRIF) | 0.48% | 0.36% |
Locked-in Retirement Account (LIRA) | 0.48% | 0.36% |
Life Income Fund (LIF) | 0.48% | 0.36% |
Tax-Free Savings Account (TFSA) | 0.48% | 0.36% |
Registered Education Savings Plan (RESP) | 0.48% | 0.36% |
Registered Disability Savings Plan (RDSP) | 0.48% | 0.36% |
Taxable Accounts | 0.11% | 0.04% |
Sources: BlackRock Asset Management Canada Limited, BlackRock Inc., Vanguard Investments Canada Inc., The Vanguard Group Inc., MSCI, FTSE Russell as of December 31, 2018
The following year, Vanguard launched the more tax-efficient Vanguard FTSE Developed All Cap ex North America Index ETF (VIU). But international stocks had already increased by over 10% during that time, which meant replacing VGK and VPL with VIU would have realized large capital gains for their existing unitholders.
Challenge #2: The Absence of Israel
The second issue related to VXC holding VGK and VPL (instead of VIU) is that Israeli companies end up being excluded. Consider this:
- VIU follows the FTSE Developed All Cap ex North America Index, which tracks stock performance in 23 developed countries.
- VGK follows the FTSE Developed Europe All Cap Index, which tracks stock performance in 16 developed European countries.
- VPL follows the FTSE Developed Asia Pacific All Cap Index, which tracks stock performance in 6 stock markets: Australia, Hong Kong, Japan, Korea, New Zealand, and Singapore.
By process of elimination, this leaves Israel’s stock market out in the cold when VIU is replaced with the VGK/VPL combo.
Source: FTSE Russell Indices as of December 31, 2018
To recap, let’s just say VXC has a number of factors working against it. All else being equal, investors may want to consider XAW instead.
That said, is “all else” ever truly equal? Maybe we Game of Thrones fans have achieved closure, but in the battle for your best-spent investment dollars, victory is rarely final. So, now that we’ve got all of those individual ETFs out of our system, it’s time for a new kind of contender. Coming up, I’ll be rolling out The Ultimate Guide to the Vanguard Asset Allocation ETFs.
Hi Justin, I enjoy watching your videos. Any reason you did not do a video for this one, VT and VXC? If you did, I can’t seem to find it.
Thank you.
@Quang Nguyen – Boredom mostly ;) I did create a video for VXC and XAW recently though:
https://www.youtube.com/watch?v=hzj-CZ38NKM
Hi Justin,
First, thanks for all you do!
It seems that Vanguard has changed the underlying holdings of VXC to hold VIU to capture the developed ex North America portion of the benchmark index, and also lowered its management fees to be in line with XAW. https://www.vanguardcanada.ca/advisors/products/documents/4156/CA
Does this change your preference? I’m sort of preferring the way Vanguard is capturing the US equity portion through 2 ETFs rather than 4. Perhaps less sampling error for the religious cap-weighted indexers?
Regards,
Robert
@Robert – VXC’s fee and underlying ETF changes were discussed on my podcast in January 2020: https://canadianportfoliomanagerblog.com/tax-me-if-you-can-foreign-withholding-taxes-on-etf-distributions/
After these changes, I would recommend VXC over XAW.
Thank you kindly! I appreciate the reply – especially on a weekend
Wait, what? Was that written correctly? You’d recommend VXC over XAW now? The article above you wrote you’d recommend XAW to investors with respect to tax efficiency, but of course that was written May 29th, 2019 and your commend is very recent and to be clear I haven’t listened to the podcast you linked, so thank you for providing that, I will definitely go an listen to it.
My question is, if you are now recommending VXC, considering tax efficiencies, does that mean if an investor has been investing in XAW (as I have in my TFSA), would it be prudent, especially if an investor is 2 or 2.5 decades away (as I am) from retirement, to close their XAW position and bulk purchase VXC and continue with buying each month VXC? Since I own XAW in a TFSA, the only cost would be the commission (likely $9.95) and the ECN fees.
Would love to know your thoughts Justin, thanks!
@Vito – I’ve discussed this already on the podcast, but I’ll be releasing a more detailed blog/video on why I would favour VXC over XAW now (and when it might make sense to make a switch).
Hey Justin,
I hope you and yours are faring well with this pandemic. I had a chance to listen to the podcast and I think the reason you prefer VXC over XAW is only because of the tax inefficiency of XAW in an RRSP or RRIF, correct?
I mean, you mentioned that you’d recommend XAW in a TFSA (as I have in mine) so now I’m wondering if its even worth closing my XAW position from my TFSA and switching over to VXC?
Can’t wait for the blog/video, I really appreciate that you’re working on this. Take care.
@Vito: My VXC vs. XAW video will be released this week, so hopefully it will answer all of your questions in detail (FYI – VXC and XAW have similar tax-efficiency across all accounts, so this is not longer a reason to favour XAW over VXC).
Hello Justin,
I have been following your and PWL capital videos, podcasts and blogs religiously and must say I have become a bit of an addict in this lockdown. I had a couple questions on this if you can help.
1. in an RRSP, if I use VT instead of ITOT, XIC, XEF and XEC (your model portfolio selection) would that not be easier? I dont feel very anamoured to a Canadian bias and feel if doing global equity diversification XIC should be 10% or less. What is your take on that?
2. Is there a calculator you can recommend where I can plug ITOT or XUU and it will do the rebalancing for me? I feel keeping track of USD ITOT and CAD XUU is a bit of a mental craziness.
3. What is the main reason for so much Single Ticket ETF having a Candian Bias?
@Anuraag: I’m glad we’ve contributed to your healthy addiction ;)
In regards to your questions:
1. VT is a decent one-fund replacement in an RRSP for ITOT/IEFA/IEMG, or VTI/VIU/VWO (for the second part of your question, see the #3 response below):
https://canadianportfoliomanagerblog.com/more-alternatives-to-vanguards-asset-allocation-etfs/
2. Unfortunately, I don’t know of any calculators that will do this work for you.
3. Lower expected portfolio volatility, lower product costs, lower annual taxes, lower unrecoverable foreign withholding taxes, less behavioural issues, etc:
https://canadianportfoliomanagerblog.com/home-bias-in-the-vanguard-asset-allocation-etfs/
Hey Justin, thanks so much for all the hard work you have put into your website and youtube videos. Your first podcast episode was excellent as well. I just learned that VXC has been updated to be more competitive. The management fee has dropped to 0.20, which would make the MER probably close to XAW. Also the structure was changed to make it more tax efficient.
Do you know the details of these changes and would you now consider VXC and XAW to equivalent choices, or does XAW still have a slight advantage. I love Vanguard, so I feel a little bit of brand loyalty, which may or may not be a good thing for my portfolio. Thanks again!
@Keith: I’ll also be briefly discussing the recent VXC changes on episode 2 of the podcast. Here are some quick thoughts:
– VXC and XAW will now be almost identical (i.e. the combined product costs + foreign withholding taxes for both will be around 0.58% annually in an RRSP/TFSA). If you love Vanguard, I think that’s a good enough reason to prefer VXC over XAW
– As VXC will need to sell VGK/VPL to buy VIU with the proceeds during 2019, there will likely be larger year-end capital gains distributions than in prior years. Vanguard has provided a conservative estimate of about $0.52/share (which is about 3 times larger than in 2018). However, they will be releasing their estimated year-end distributions in December, so this could change
– If you’re a taxable investor who is considering the purchase of VXC, you may want to wait until after the year-end distribution (if you’re purchasing it in an RRSP/TFSA, you don’t need to worry about tax implications)
Another outstanding article. Thank you Justin. I have been concerned in the past about US estate taxes. You have laid those fears to rest as I comfortably under the 11 million threshold.
@David Dalton: That makes at least two of us! ;)
Hi Justin,
Thank you for your amazing blog posts and videos! I have learned a lot!!
I have been looking at the CPM and PWL model ETF portfolios and I am wondering why U.S. listed ETFs are only shown for the RRSP and RRIF accounts? Would it not make sense to hold ITOT/IEFA/IEMG(or VWO) in taxable accounts to save on foreign withholding taxes and product fees (through the use of the Norbert’s Gambit technique)? Thanks!
@JR: Glad you’ve been enjoying them!
Holding ITOT, IEMG or VWO would not reduce the amount of unrecoverable foreign withholding tax in a taxable account, relative to XUU, XEC or VEE (so the only benefit would be a reduction in product fees (you would have to decide whether it’s worth the additional complexity of using Norbert’s gambit).
Holding IEFA in a taxable account (instead of XEF) would actually result in more foreign withholding tax drag.
Please check-out my CPM Foreign Withholding Tax Calculator, which should assist you with your decisions:
https://canadianportfoliomanagerblog.com/calculators/
Thanks. Have a large lump sum to invest in my RRSP was deciding between VT and XAW… seems clear that from a tax efficiency perspective. Best to keep VT in my RRSP and XAW in My TFSA
Hi Justin, I am very tempted to convert from VGRO/VBAL to a 3 ETF portfolio using ZAG, VCN and VT/ XAW. Is there any broad index inter listed ETF to perform Norbert’s gambit and at the same time stay invested? Many thanks!
@Art: Not that I know of. You may want to consider working with a brokerage which allows you to perform the gambit and all other ETF trades on the same day (like RBC Direct Investing or BMO InvestorLine).
Hi Art. To this end, I already made a Norbert’s gambit with HXS / HXS.U, which follows the S&P500 index. It was with the broker Disnat (Desjardins), which does not support the operation in one day.
Hello Justin,
In future could you please write an article on ETF’s and their potential exposure to US estate taxes
as well as the T1135 disclosure.
BMO claims that many of their ETF’s are protected from US Estate taxes and many do not have
to be declared on the T1135. I was wondering if all canadian listed ETF’s that hold stock directly
have this benefit.
@Ian: I can certainly put it on the list, but here’s a quick breakdown:
US estate taxes (for Canadians) is only an issue if your worldwide estate (i.e. all of your assets) is worth more than $11.4 USD million when you die (so most Canadian investors can breathe a sigh of relief):
https://ca.rbcwealthmanagement.com/documents/233544/0/U.S.+Estate+Tax+for+Canadians+in+2019.pdf/ba88e6ce-fb64-4abe-bb57-8a6f4c3dad22
Any Canadian-domiciled ETF that holds U.S. or foreign equities (i.e. XUU, VUN, ZSP, XEF, VIU, ZEA, XEC, VEE, ZEM, XAW, VXC, etc.) do not need to be declared on a T1135 report, and are also not considered U.S. situs property (for U.S. estate tax purposes), for those investors with estates above $11.4 USD million (so BMO is correct with their claim).
Seriously, thank you Justin for taking YOUR time to write such incredible articles like this one. I can’t wait to read your next article, since my TFSA is invested mostly in VGRO and in VCIP.
A quick question : If the market dropped 15-20% like in October to December 2018, how would you feel about borrowing an amount you can repay on your own, say like 10-20k and invested it in VGRO or VEQT ? This is market timing, obviously, and I know from my years of investing in indexing and market efficiency that this is a bad thing! Your thoughts on that subject ? (No worries, this is not a financial consultation!)
Thank you and thank you again!
JFLD
JFLD: Honestly, when I receive kind comments like yours, it reminds me why I write these articles :)
If you have gone through the financial planning process, know how much you need to save to meet your goals, know how much risk you need to take, and are comfortable with that amount of risk, I’d just get back to enjoying the better things in life (and not worry about leveraging or timing the market).
Having said that, remember that if markets go down by 20%, Vanguard will be selling bonds within VGRO and VCIP and buying back equities, so you get to buy more equities automatically without any effort (and without leverage).
You are right! My plan will allow me to reach my objectives without using leverage. This is simply my little voice that constantly wants me to take actions to improve my return, reduce the time to reach the objective. It is the hardest part, to simply follow the plan and forget about it!
thank you for your answer Justin! wish you all the best !
Take care,
Best regards,
JFLD
Hey Justin,
The article makes it clear that due to being more tax-efficient, XAW is preferred over VXC (all else being equal).
Any thoughts on XAW vs VIU?
I’m kind of assuming they’re expected to have very similar returns, since VIU “fixes” the tax situation with VXC…
Thanks as always for your very pertinent and well-written posts!
@Gabriel: You’re very welcome! Just to clarify, do you mean, what would happen if you replaced VXC with a trio of VUN/VIU/VEE (and compared it to XAW)?
This would fix the tax-inefficiency in VXC – the FWT in a TFSA and RRSP would be 0.35% (similar to XAW’s FWT of 0.36%) and 0.03% in a taxable account (similar to XAW’s FWT of 0.04%).
The weights I used were based on the global equity market caps as of December 31, 2018 (feel free to test it out in the CPM Foreign Withholding Tax Calculator):
https://canadianportfoliomanagerblog.com/calculators/
Allocation:
VUN = 55.25%
VIU = 33.97%
VEE = 10.78%
Hi Justin, thanks a lot for your great series and insight (big fan). Will you also be doing a guide/analysis of the iShares and BMO Asset Allocation ETFs? Also, related to this, will you be adding the BMO asset allocation ETFs to your foreign withholding tax calculator at any point? Like the XAW vs VXC comparison, wondering how ZGRO holds up to VGRO and XGRO for example.
@Matt: Glad to hear I have a big fan! ;)
To answer your questions: Yes to the iShares/BMO AA ETF guide, and yes to the BMO AA ETFs in the FWT calculator (maybe a summer task?).
ZGRO will likely have very similar FWT drag to VGRO or XGRO (so the results will probably not be too exciting).