Distributing vs Accumulating ETFs

[GeoffF100]

Originally, Vanguard offered only distributing ETFs on its own platform. When interviewed, Vanguard's representatives would not say why.

Many of the distributing ETFs pay their dividends in USD. Monevator has been recommending the accumulating ETFs to avoid paying FX costs to covert the dividends to GBP. It came to my attention recently that Vanguard has been offering the accumulating versions on its own platform for more than a year.

I have a holding of VFEM with iWeb. I wondered whether it was worthwhile converting that to VFEG. The dividend rate is 2.95% according to HL. iWeb presumably charges 1.5% FX commission to convert that to GBP. (They do not give the time of the conversion, so I cannot check that.) I expect that I lose about 3% * 0.015 = 0.045% of my investment each year to FX costs. That is £45 per £100K.

The downside is the market spread. VFEM has an indicative spread of 0.11% right now, according the HL, whereas VFEG has an indicative spread of 0.74%. The cost of conversion would be (0.11% + 0.74%) / 2 = 0.425%. I would break even after 0.425 / 0.045 = 9.4 years. Hopefully, the spreads will fall, so it is not worth doing anything right now.

I expect Vanguard's reason for not wanting to offer the new accumulating ETFs on their own platform was that the accumulating funds' prices were could be all over the place and their spreads could be huge, but they did not want to say that.

[EthicsGradient]

I'm not sure how accurate HL's "indicative spreads" are, however. Looking at the Stock Exchange pages for those 2, I see current bid/offer prices of:

VFEM 42.63/42.72 = 0.21% https://www.londonstockexchange.com/sto ... mpany-page
VFEG 42.62/42.79 = 0.40% https://www.londonstockexchange.com/sto ... mpany-page

so only 0.19% to make up in the exchange charges advantage.

But I'm not sure why you take the average of the 2 spreads as what you need to compare the annual exchange charges to. Surely it should be the difference between the spreads?

[Newroad]

Hi Geoff.

The relevant cases for me are VWRL and VWRP. We hold the former in our ISA's (where II do forced conversions, as they cannot hold USD) and the latter in our SIPPs (which can hold USD, but more for the inconvenience, rather than the cost, as we don't wish to have to manually convert).

At time of writing, the spread on VWRL was 90.05 - 90.09p, on VWRP was 88.09 - 88.13p, so that side of things is a non-issue. As you allude to below, maybe it will become that way for VFEM vs VFEG in due course.

Regards, Newroad

[GeoffF100]

But I'm not sure why you take the average of the 2 spreads as what you need to compare the annual exchange charges to. Surely it should be the difference between the spreads?

If I sell VFEM, I pay half the spread on VFEM. If I then buy VFEG. I pay half the spread on VFEG. In total, I pay half the spread on VFEM plus half the spread on VFEG, which is equal to the spread of VFEM plus the spread of VFEG, all divided by two, i.e. the mean of the two spreads.

HL now showing an indicative spread of 0.39%. London Stock Exchange bid/off spread now works out to 0.38%. Clearly, the spread (and I expect the premium/discount to NAV) can vary a lot for VFEG. I have just found out that iWeb does not offer VFEG, so I could not check the actual quoted spread.

[GeoffF100]

I have just checked VEVE/VHVG and VAGP/VAGS. The accumulating versions seem reasonably priced there. It is certainly an improvement on when I last looked. I expect that VFEG is still not much traded.

I have got a free for life account with Vanguard, so I can avoid FX charges by transferring my ISA over to them. That would fully nail my colours to the Vanguard mast as far as equities are concerned. I am not entirely happy about having about 50% of my NAV in one account, but I do not expect that Vanguard is going bust any time soon.

I have recently added a section to my tracking spreadsheet which totals up the OCFs of my Vanguard funds, which has concentrated my mind. I am paying them a lot of money. My brokerage charges are pretty insignificant by comparison.

[richfool]

The thought that came into my mind, was whether there are any implications due to the exchange rate spread, when considering distributing or accumulating versions? E.g. if I receive a distributed dividend on a dollar fund, a currency exchange (with my broker) will take place. However, if on the other hand, I invest in an accumulation version, does any currency exchange occur, or does the supposed dividend just get ploughed into the capital amount of the investment?

[GeoffF100]

The thought that came into my mind, was whether there are any implications due to the exchange rate spread, when considering distributing or accumulating versions.

It is possible that Vanguard will get a tighter FX spread than your broker, which would favour the accumulating versions.

[Newroad]

Hi Geoff.

I think the VAGP/VAGS is a bit of a red-herring in the original context (avoiding FX costs/inconvenience) as, at least as far as I can tell, VAGP (unlike say VWRL) pays distributions in GBP - possibly because it's GBP hedged.

Regards, Newroad

[GeoffF100]

Thanks. I had not noticed that.

[GeoffF100]

However, if on the other hand, I invest in an accumulation version, does any currency exchange occur, or does the supposed dividend just get ploughed into the capital amount of the investment?

The underlying assets will be denominated in many currencies. Accumulating funds do not appear to reinvest dividends as they go along. I expect that the dividend will be paid in USD, and an accumulating fund will buy shares at the dollar denominated price. That money will then be converted into the many currencies that are required to buy the underlying assets.

[EthicsGradient]

But I'm not sure why you take the average of the 2 spreads as what you need to compare the annual exchange charges to. Surely it should be the difference between the spreads?

If I sell VFEM, I pay half the spread on VFEM. If I then buy VFEG. I pay half the spread on VFEG. In total, I pay half the spread on VFEM plus half the spread on VFEG, which is equal to the spread of VFEM plus the spread of VFEG, all divided by two, i.e. the mean of the two spreads.

HL now showing an indicative spread of 0.39%. London Stock Exchange bid/off spread now works out to 0.38%. Clearly, the spread (and I expect the premium/discount to NAV) can vary a lot for VFEG. I have just found out that iWeb does not offer VFEG, so I could not check the actual quoted spread.

Ah, OK, I had been thinking in terms of "which to buy from scratch", and I see you had said you already hold VFEM.

But I'm not convinced by the "divide by 2", justified by "you pay half of each spread now". Yes, but unless you assume the VFEG spread will decrease in the future to exactly the same as the VFEM, you'll still pay more when you finally sell to get cash.

If you currently hold X shares of VFEM, you can sell them (with the prices I gave) for £X*42.63, and buy X*42.63/42.79 VFEG. Then you can sell those for £X*42.62*42.63/42.79; or 42.62*42.79 times the VFEM value - ie we're just back at the bid/offer spread for VFEG as your loss, at the moment anyway. If the spread will decrease, it's hard to say whether that will come from a change in bid, offer, or a bit of both.

[GeoffF100]

I clearly have not spelt this out enough. The critical points are that I am using mid-market valuations, and linear approximations to make the arithmetic simple. With your approximate percentage spreads:

VFEM 42.63-42.72 spread = 0.21%
VFEG 42.62-42.79 spread = 0.40%

The simple calculation is:

Sell VFEM lose 0.105%
Buy VFEG lose another 0.20%
Total lost = 0.305%

Lets spell out the calculation to greater accuracy:

Hold x VFEM shares
Mid market price = (42.63+42.72)/2 = 42.675
Spread = 0.09
Mid market value = 42.675x
Sell for 42.63x
Lost 42.675x - 42.63x = 0.045x
Percentage loss = 0.045x*100/42.675 = 0.105448%

Buy VFEG at 42.79
Number of shares bought = 42.63x/42.79 = 0.996261x
Mid market price = (42.62+42.79)/2 = 42.705
Spread = 0.17
Mid Market value = 0.996261x * 42.705 = 42.5433x
Lost 42.63x - 42.5433x = 0.0867x
Percentage loss = 0.0867x*100/42.63x = 0.203378%

Clearly, the linear approximation is accurate enough here. The numbers are changing from minute to minute, and we want a simple calculation.

We know what the spread is at the instant that we make a trade, but we do not know what the spread will be in the future. Spreads have gone down by more than a factor of ten since I was a young man. A mid market approximation is certainly appropriate if the spread shrinks to a negligible value by the time we sell. That may not be completely realistic, but it is good enough when the value soon fluctuates by more than the spread anyway. All we want to know here is roughly what percentage we will lose as a result of our trading.