Tracker Fund and ETF versions of the SAME investment

[Justin]

Hello,

First time here, hello everyone.

I was wondering if anyone could illuminate the differences between a Tracker Fund and an ETF of the SAME investment.

As fas as I can tell, the Vanguard FTSE Developed Europe ex-U.K. Equity Index Fund and the Vanguard FTSE Developed Europe ex UK UCITS ETF (VERX) both have the same underlying invesment portfolio. Although there is a tiny difference in the total number of investments in each, the % exposure by country, sector, and individual holdings are identical. The OCFs are identical. So the only difference is that the ETF is constantly tradeable and the fund trades once a day.

Can someone explain why some people might go for one rather than the other, or conversely why Vanguard might offer the same investment in these two different formats?

Many thanks

Justin

[Justin]

Responding to my own post....

I've had a response from Vanguard and it looks like there is little to choose between the IT version and the ETF version of the European ex-UK fund ...
- you can buy franctional units in the IT version
- immediate trading with the ETF version
- IT version is UK domiciled.
So, not much there. Presumably there are some platforms that charge differently for ITs vs ETFs, but I'm on iWeb.

However they have done the same thing for their FTSE 100 Tracker - an IT version and an ETF version - and there there is greater difference:
- entry charge of 0.45% for the IT version (0% for the ETF)
- 0.06% OCF for the IT version, 0.09% for the ETF version.
So the IT has an entry charge equivalent to five years of ongoing charges with the ETF version.

[Alaric]

I've had a response from Vanguard and it looks like there is little to choose between the IT version and the ETF version of the European ex-UK fund ...

I think you mean OEIC version. If IT stands for Investment Trust, these are traded on the Stock Market in the same way as ETFs, so continuous trading and no fractional holdings.

OEIC Open Ended Investment Company
IT Investment Trust

OEICs were previously Unit Trusts, it's the same general construction but a slightly different legal framework.

[Lootman]

There are a few issuers who will offer both OE funds and ETFs for the same underlying index. Where I think Vanguard is unique is that they offer both AND both variants are based on exactly the same underlying pool of assets. At least, that is how their US index offerings work - I'm not certain the UK ones do, yet.

So what this means is that the OE and ETF variants can really be seen as different share classes of the same product. Which just leaves the investor with a choice of which to use, which comes down to personal preferences.

So if you hold only funds currently then you might elect the OE variant. Whereas if you hold only shares and ITs, then you might choose the ETF.

More sophisticated investors might typically choose the ETF because of the ability to trade intra-day, go short, use options and so on. But given that most people hold index funds for the long-term, I'd suggest it doesn't make too much difference. Either way, I personally rate Vanguard very highly.

[Alaric]

Where I think Vanguard is unique is that they offer both AND both variants are based on exactly the same underlying pool of assets.

A simple way to work that trick is for the OIEC to hold shares of the ETF. You might get a marginal tracking error when the OIEC has liquidity resulting in it not being 100% invested.

[hiriskpaul]

It is not likely to make a huge difference which you choose if you are intending to hold over the long term, but there are some small differences that I think may favour the OEICs over ETFs:

- OEICs only trade once per day, but do so at NAV. ETFs trade all the time, but trade at small premia/discounts to NAV, so there is a risk you may end up paying more than the NAV when you buy and selling at a discount. There is also a small bid/offer spread on the ETFs which you typically do not see on the OEICs. Curiously the UK ETFs VUKE/VMIDD often trade slightly above NAV. I think this must be due to stamp duty on UK shares, but have never quite got my head round how this works its way into a NAV premium.

- OEICs pay out dividends in pounds, ETFs usually in dollars or Euros, except where the underlying are UK shares. The foreign currency is then converted by your broker into pounds at a rate lower than the interbank rate. Depending on your broker, that can add a few bps to your running costs. For example, one of the worst is Hargreaves Lansdown who charge 1.7% to convert dividends, so on an ETF yielding 2%, that is equivalent to an extra annual charge of 0.034% on your investment. I have never found out what Vanguard charge to convert dividends in their OEICs, but would expect it to be a negligible amount otherwise it would show up in tracking error.

- OEICs are regulated retail investments and come with some FSCS protection. For actively managed funds the retail protection is important as the FCA will force a fund manager to compensate investors if there is any financial or investing irregularities in the fund. I would not overemphasize the importance of this in the case of tracker funds though. Irregularities will show up very quickly in tracking error. Furthermore it is difficult to see why someone running a tracker fund would get up to mischief, but in the case of active funds, the fund manager might be tempted to chase performance by breaking the rules and investing in risky areas outside his/her remit.

- ETFs pay dividends quarterly, except accumulating ETFs of course, OEIC equivalents typically annually or semi-annually. Some people may prefer quarterly dividends, although the level can very widely across quarters.

All the above are minor considerations. If your broker charged a platform fee for holding OEICs (as many do), I would definitely hold ETFs instead.

[genou]

- OEICs pay out dividends in pounds, ETFs usually in dollars or Euros, except where the underlying are UK shares. The foreign currency is then converted by your broker into pounds at a rate lower than the interbank rate. Depending on your broker, that can add a few bps to your running costs. For example, one of the worst is Hargreaves Lansdown who charge 1.7% to convert dividends, so on an ETF yielding 2%, that is equivalent to an extra annual charge of 0.034% on your investment. I have never found out what Vanguard charge to convert dividends in their OEICs, but would expect it to be a negligible amount otherwise it would show up in tracking error.

Just for completeness - many ( most of interest to Fools? ) ETFs will have multiple quotes, one of which will be in Sterling, so that broker FX charges can be avoided.

[hiriskpaul]

- OEICs pay out dividends in pounds, ETFs usually in dollars or Euros, except where the underlying are UK shares. The foreign currency is then converted by your broker into pounds at a rate lower than the interbank rate. Depending on your broker, that can add a few bps to your running costs. For example, one of the worst is Hargreaves Lansdown who charge 1.7% to convert dividends, so on an ETF yielding 2%, that is equivalent to an extra annual charge of 0.034% on your investment. I have never found out what Vanguard charge to convert dividends in their OEICs, but would expect it to be a negligible amount otherwise it would show up in tracking error.

Just for completeness - many ( most of interest to Fools? ) ETFs will have multiple quotes, one of which will be in Sterling, so that broker FX charges can be avoided.

Agreed, definitely buy the ETFs priced in Sterling. However, the divis will still be paid in the underlying currency of the fund, so you cannot escape the additional foreign dividend broker fee. Some brokers are better than others in handling foreign currency dividends of course. IG only charge 0.3% and offer the option of holding the foreign currency for non-ISA accounts, which is just as well as they don't offer OEICs!

[Lootman]

Just for completeness - many ( most of interest to Fools? ) ETFs will have multiple quotes, one of which will be in Sterling, so that broker FX charges can be avoided.

Agreed, definitely buy the ETFs priced in Sterling. However, the divis will still be paid in the underlying currency of the fund, so you cannot escape the additional foreign dividend broker fee.

True but then you have that problem with any method of investing in foreign securities, be it ETF, IT, OEIC or the shares themselves. It's not unique to ETFs nor a reason to choose an OEIC instead.

The reason to get the sterling class of an ETF (which exists for every ETF that I hold) is that the institutional rate of FX applied will be much more favourable to the rate a broker may use.

[hiriskpaul]

Just for completeness - many ( most of interest to Fools? ) ETFs will have multiple quotes, one of which will be in Sterling, so that broker FX charges can be avoided.

Agreed, definitely buy the ETFs priced in Sterling. However, the divis will still be paid in the underlying currency of the fund, so you cannot escape the additional foreign dividend broker fee.

True but then you have that problem with any method of investing in foreign securities, be it ETF, IT, OEIC or the shares themselves. It's not unique to ETFs nor a reason to choose an OEIC instead.

The reason to get the sterling class of an ETF (which exists for every ETF that I hold) is that the institutional rate of FX applied will be much more favourable to the rate a broker may use.

With an ETF, the broker converts the foreign dividend. With a OEIC, the fund manager does. I am sure that Vanguard convert at a much better rate than many of the brokers do. So all I am saying is that if you happen to be with a broker that charges a lot for currency conversion, that might tip the balance in favour of the OEIC, for that particular broker. For many brokers the ETF would usually be better if the broker charges high platform fees for OEICs.

[Blagdon]

Do you pay stamp duty with the OIEC but not with the ETF ?

[paulnumbers]

So, not much there. Presumably there are some platforms that charge differently for ITs vs ETFs, but I'm on iWeb.

Iweb are more the exception than the rule. Halifax, Iweb and I believe Interactive Investor are the only platforms that I'm aware of that don't charge a % fee for funds - and that includes Vanguards own platform.

I've never managed to find out why that might be case, so if anyone knows I'm very interested to find out.

[TedSwippet]

Do you pay stamp duty with the OIEC but not with the ETF ?

No. Well, mostly no. But... while you don't pay explicitly, the stamp duty payable on any UK shares bought inside and by the fund has to lurk somewhere.

ETFs traded on the LSE are free from explicit stamp duty, so it merely hides somewhere inside the general annual OCF. OEICs are free from explicit stamp duty too, although a couple of Vanguard ones have something called a 'dilution levy' that is in effect a small initial charge that you pay on purchasing them, and which covers UK stamp duty. They apply it only on OEICs with a large UK equity component, and it's generally lower than 0.5%. If an OEIC has UK stocks but no dilution levy the stamp duty is, as with the ETF, hidden in the OCF.

The lack of dilution levy on ETFs can make them the better bet, but it's tricky to calculate out if that offsets potential ETF inconveniences such as forex charges on dividend payments, general lack of 'accumulation' options -- a few accumulation ETFs do now exist, but not from Vanguard -- bid/offer spreads and so on.

[mc2fool]

Halifax, Iweb and I believe Interactive Investor are the only platforms that I'm aware of that don't charge a % fee for funds

Alliance Trust Savings

[hiriskpaul]

Stamp duty is paid when UK shares are purchased. For cap weighted funds there is very little turnover, so for OEICs that is when new units are created and for ETFs, when shares are purchased which are then "swapped" for ETF shares.

If you buy ETF in the secondary market, the stamp duty has already been paid on the underlying shares, but I think the no free lunch comes in because the ETF trades at a premium to NAV most of the time, so you are effectively paying too much when you buy and receiving too much when you sell. Because you are paying slightly too much, you are getting slightly less in dividends than you would had you bought at NAV and this will show up in long term tracking difference in the total return. Probably really hard to spot though as the management fee is likely to be quit a lot more. Paying a premium of 0.5% on an underlying portfolio yielding 4% implies about 0.02% loss per year. I could easily be wrong about this, or some details of it, and I have not had it confirmed by Vanguard, etc., but I think this is what is happening.

OEICs only trade once per day and provided money coming in matches or is less than money going out (bought units < sold units), no new units are created, so no shares need to be purchased and no stamp duty paid. When there is more money coming in than going out, some stamp duty is paid, but typically less than 0.5% as there are likely to be some unit sellers as well. Vanguard impose an explicit levy on some of their OEICs in order to protect longer term holders. Other tracker providers do something similar but are less up-front about it. The Vanguard levy is not kept by Vanguard by the way, it is paid into the fund. So quite different to the old up-front charges that OEICs and UTs used to have, which got paid out to financial advisers, brokers, or simply pocketed by fund managers if you went direct.

[Lootman]

Do you pay stamp duty with the OIEC but not with the ETF ?

No. Well, mostly no. But... while you don't pay explicitly, the stamp duty payable on any UK shares bought inside and by the fund has to lurk somewhere.

That's slightly different though. Clearly any type of fund that invests in UK shares will have underlying stamp duty payable. But ETFs and OEICs have an advantage over investment trusts because the latter attract stamp duty when you buy them AND still suffer from the underlying stamp duty when the IT buys shares.

So competitively, ETFs and OEICs are better than ITs, purely from a stamp duty perspective.

Obviously if the fund is invested in foreign shares, then there is no underlying stamp duty, but an overseas IT will still cost 0.5% in stamp duty to buy. Some ITs investing overseas have domiciled themselves in places like Jersey for tax reasons - no stamp duty and no corporation tax. ITs pay corporation tax because they are companies - funds do not.

[Justin]

Many thanks to everyone who responded - very thoughtful, wise and kind.

Justin (OP)

[Sixtyone]

Hello, hope it's OK to jump on an old thread,

I hold the Vanguard FTSE Developed Europe ex-U.K. Equity Index Fund in my HL SIPP for which I pay 0.45%. My other SIPP ETF's mean my costs are capped at £200, so it seems like a no brainer to sell up and buy VERX. The spread and dealing costs would be recovered in no more than 2 months. Am I missing something here ?

Thanks

[paulnumbers]

In case you're interested Justin, I found the following link explanation of the differences between ETF's and OEIC's quite interesting (although it doesn't actually answer your question!)

https://www.reddit.com/r/UKPersonalFina ... d_tracker/

[colin]

For those investing less than £2000 per purchase ETFs are usually un economical compared to OEICs, it all depends on whether you have to pay a dealing fee to buy the OEIC version, it used to be that no one paid such a pfee but OEIC charges were higher than ETF charges, these days that's not always so. Certainly consider the cost of re investing dividends if that's what you plan to do.