If you’re a long time reader, you know that we deploy a hybrid investment strategy – we hold both individual dividend-paying stocks and index ETFs in our dividend portfolio. When it comes to an international index ETF, we hold VXC. Lately, I have been wondering if it makes sense to sell VXC and purchase XAW because of XAW has a lower MER fee and higher distribution yield. VXC vs. XAW, which one of these ex-Canada international ETF is better?
Update: XAW and VXC now have very similar MER and distribution yield. Unless there’s a compelling reason for you, it probably makes no sense to switch. Pick one of these ETFs and go with it.
History of VXC and XAW
In July 2014, Vanguard Canada released the Vanguard FTSE All-World ex Canada Index ETF (VXC). This international ETF gave Canadians exposure to large and mid-sized companies outside of Canada. Most of VXC’s underlying holdings are existing US-listed Vanguard ETFs. VXC has an extremely low MER of 0.27%.
In Feb 2015, iShares released the iShares Core MSCI All Country World ex Canada Index ETF (XAW) which mimics VXC closely but at a slightly lower MER of 0.22%. Similar to VXC, most of XAW’s underlying holdings are existing US-listed iShares ETFs with one exception. I’ll discuss this exception later.
VXC vs. XAW sector allocation
Below is the sector allocation breakdown for VXC and XAW. As expected, they are very close to each other.
|Oil & Gas||5.5%||5.46%|
|Cash and/or Derivatives||0.0%||0.55%|
VXC vs. XAW country allocation
|Cash and/or Derivatives||0.00%||0.55%|
Why we own VXC
Now you are probably wondering, why the heck did we purchase VXC when XAW appears to be a better product due to its lower MER and higher yield? Well, when Dan Bortolotti and his team at Canadian Couch Potato constructed the ETF model portfolio a number of years ago, VXC was the recommended international ETF to use. So when we wanted to increase our international diversification, naturally, we picked VXC. Throughout the past number of years, we have been adding VXC shares in lumped sum transactions as well as a few shares every other month to take advantage of Questrade’s no commission ETF purchase. We own hundreds of shares of VXC across our RRSPs and taxable accounts.
When you look at Canadian Couch Potato’s model portfolio now, VXC is no longer the recommended international index ETF. Instead, XAW is the recommended international ETF. According to Justin’s analysis at Canadian Portfolio Manager, he noted that XAW has a lower overall fee
In fact, according to Justin’s calcuation, the estimated cost of VXC increases to 0.66% (from 0.27%) while the estimated cost of XAW increases to 0.56% (from 0.22%).
In addition, XAW has a slightly higher distribution yield than VXC. XAW has a trailing12 months yield of 2.13% while VXC has a trailing 12 months yield of 1.93%.
As a result, XAW has a 0.10% fee advantage and a 0.20% distribution yield advantage over VXC. Or an overall advantage of 0.30%.
Putting numbers into perspective
What do the 0.10% fee and 0.20% distribution yield advantages mean? We need to put this into a bit of quantitative perspective. Let’s imagine different portfolio values, starting at $5,000 to $3,000,000.
|International Portfolio Size||VXC 0.66%||XAW 0.56%||Annual Fee Delta||VXC Yield 1.93%||XAW Yield 2.13||Annual Yield Delta||Total Delta||% of Porfolio|
Note 1: We are assuming that the two ETFs have exactly the same rate of return
Note 2: The last column is a bit unnecessary but I wanted to show that the overall % as part of your international portfolio is 0.30%
So when the international portfolio size is relatively small (say less than $100,000), you’re talking a $100 annual difference in fee and a $200 annual difference in distribution. That’s $300 in total or 0.30% of your international portfolio. And if you’re using a balanced portfolio approach (40% bonds, 20% Canadian, 40% international), that means your overall investment portfolio is $250,000. The $300 cost difference is 0.12% of your overall portfolio.
When the international portfolio size is large (say $500,000), the total difference is $1,500. Again that’s merely 0.30% of your international portfolio or 0.12% of your overall portfolio (again, assuming the balanced portfolio approach). Below are the respective overall fees as part of the overall portfolio.
|Overall Portfolio, at $500k international||$2,500,000||$1,666,667||$1,250,000||$1,000,000||$833,333|
|$1,500 fee as % of overall portfolio||0.06%||0.09%||0.12%||0.15%||0.18%|
If you look at the “big” picture, the fee is a very small fraction of your overall portfolio value.
What should we do – some thoughts
I get it, nobody wants to pay extra fees when you don’t have to. But let’s put the total amount into perspective, it’s a very small fraction of your overall portfolio value. If your overall portfolio is $1.25M, paying an extra $1,250 each year is probably not going to cause you to lose sleep. Similarly, an extra $30 on a $25,000 portfolio ($10,000 international, balanced approach) probably won’t cause you to lose sleep at night either.
Heck, if we had $100k in international ETFs, the time it took me to analyze the data and write up this post has already exceeded $300 fee & distribution difference between holding VXC vs. holding XAW!
Given all the data available, what should we do moving forward?
As mentioned already, we hold a large quantity of VXC shares across different accounts (RRSPs & taxable accounts). So if we were to liquidate all of our VXC shares and replace them with XAW shares, we would need to do a total of 4 transactions. At $4.95 per transaction for Questrade and $9.99 per transaction for TD Waterhouse, this means we’d have to pay $24.84 to sell everything. We would need to spend another $9.99 to purchase XAW shares with TD Waterhouse (buying ETFs are free for Questrade). That’s a total of $34.83 in commissions for switching the international ETF, not to mention we’d have to pay taxes for the capital gains too.
In the end, I have to ask myself, does it make sense to switch from VXC to XAW and take the commission hit for the long term gain? After examining all the factors and considering that we plan to hold international ETF for the next 20, 30 years or longer, it makes sense to switch from VXC to XAW.
In the case that you want further diversification and don’t want to bother picking between equity ETFs and bond ETFs, you should take a look at some of the all-in-one ETFs that you can hold as a Canadian. These can result in simplicities for some people.
Does it make sense for us to switch from VXC to XAW given we own a large quantity of VXC? Considering the commission cost and capital gain tax to switch and the long term gain after switching, I believe the answer is yes.
Going through this exercise made me wonder about this question – how far do you go to save a few percentages? What happens if in the near future another company (say Horizons) releases an international ETF with an even lower overall fee than XAW? Do we switch again? When will the chase for a lower fee ETF end?
Dear readers, do you hold VXC or XAW? Have you made the switch?