Difference between revisions of "Index funds and ETFs outside of the US"

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There are several studies related to [[Safe withdrawal rates|safe withdrawal rates]] across the globe:
 
There are several studies related to [[Safe withdrawal rates|safe withdrawal rates]] across the globe:
* [[Wade Pfau|Pfau]]: [https://www.advisorperspectives.com/articles/2014/03/04/does-international-diversification-improve-safe-withdrawal-rates  Does International Diversification Improve Safe Withdrawal Rates] and [https://retirementresearcher.com/4-rule-work-around-world/ 4% Rule Work Around World/]
+
* [[Wade Pfau|Pfau]]: [https://www.advisorperspectives.com/articles/2014/03/04/does-international-diversification-improve-safe-withdrawal-rates  Does International Diversification Improve Safe Withdrawal Rates] and [https://retirementresearcher.com/4-rule-work-around-world/ Does the 4% Rule Work Around World/]
 
* Portfolio charts: [https://portfoliocharts.com/withdrawal-rates-faq/ Withdrawal Rates FAQ] and [https://portfoliocharts.com/2017/06/09/your-home-country-is-inseparable-from-your-withdrawal-rate/ Your Home Country Is Inseparable From Your Withdrawal Rate]
 
* Portfolio charts: [https://portfoliocharts.com/withdrawal-rates-faq/ Withdrawal Rates FAQ] and [https://portfoliocharts.com/2017/06/09/your-home-country-is-inseparable-from-your-withdrawal-rate/ Your Home Country Is Inseparable From Your Withdrawal Rate]
 
* The "Investing in the World" articles by Siamond on the Bogleheads blog: [https://finpage.blog/2017/03/18/investing-in-the-world-part-1/ Investing In The World (part one)], especially this [https://blbarnitz4.files.wordpress.com/2017/03/invest-world-blog3-table.jpg table].
 
* The "Investing in the World" articles by Siamond on the Bogleheads blog: [https://finpage.blog/2017/03/18/investing-in-the-world-part-1/ Investing In The World (part one)], especially this [https://blbarnitz4.files.wordpress.com/2017/03/invest-world-blog3-table.jpg table].

Revision as of 17:34, 14 September 2019

Ambox globe content.svg This article contains details specific to non-US investors. It does not apply to United States (US) investors, or to US citizens and US permanent residents (green card holders) living outside the US.

Index funds and ETFs outside of the US: ---> Group here the info on index funds outside of the US -- move lot of info from investing from outside of the US and from the irish ETF page


Regulation priips mifid

Kinds of funds

UCITS index funds

US index funds

Australian index funds

Cost and taxation related to UCITS index funds and ETFs

Expense ratio

Other costs

  • hedging

Hedging

Guidance and decision tables for Non-US investors

  • Nonresident alien with no US tax treaty & Irish ETFs: This page intends to discuss why it may be better for a nonresident alien with no US tax treaty to invest in Ireland domiciled exchange-traded funds (ETFs) as opposed to the popular US domiciled mutual funds discussed often by US-based investors.
  • Non-US investor's guide to navigating US tax traps: US tax laws contain multiple traps for unwary non-US investors. This page contains a guide for non-US investors planning to use index tracker funds or ETFs, with the aim of helping these investors to avoid falling into US tax traps by navigating around, through, or between them.
  • Nonresident alien's ETF domicile decision table: When selecting an index tracking fund, US nonresident alien investors have a broad choice between US domiciled ETFs and non-US domiciled ETFs. This page summarises the recommended ETF domicile that US nonresident aliens might use, based on their own country of residence and domicile. The goal is for investors to obtain the best tax result.

Accumulating/capitalizing vs. distributing ETF share classes

One of the biggest difference between US domiciled ETFs and EU domiciled ETFs is that EU domiciled ETFs can reinvest the received dividends/interests, without distributing them. Let's say that an ETF holds a number of stocks. The ETF keeps receiving dividends from these stocks periodically. In the US, a fund must distribute these dividends to the investors. In the EU, the ETF can either distribute the dividends, or immediately reinvest back into the ETF, buying more stocks.

There are a few things to consider with distributing ETFs. The country of the fund might withhold dividend taxes, you may have to pay dividend tax in your own home country, and then when you reinvest the dividends you must also pay both brokerage commissions and the bid/ask spread. By using capitalizing/accumulating ETFs you might be able to avoid some of these.

Some countries in Europe do not tax dividends if they are reinvested by the fund itself. In those countries, buy only capitalizing/accumulating ETF shares, but consult your tax advisor before doing so. In other countries there is no benefit to this type of share.[note 1]

The Key Investor Information Document (KIID, or sometimes just KID) of an ETF will tell you whether it is accumulating or distributing[1].

Base currency vs. trading currency vs. currency of the underlying asset

The same ETF can have different share classes, and can be listed on several different stock exchanges. For example, the SPDR® MSCI ACWI IMI ETF is listed on 5 different stock exchanges, and in different currencies tracks the MSCI All-Country World Investable Market Index, which is a truly global index.

Where should you buy it, and in which currency?

The base currency of the fund is USD. This means that the ETF shares are managed in the USD currency, and the tracked index is also quoted in USD. You can also buy the ETF shares in the USD, EUR, GBP or CHF[note 2] currencies, on different stock exchanges. This is useful if your money is in EUR, GBP or in CHF, and not in USD, and you don't want to exchange your money for USD.

It is important to understand that the real currency risk is linked to the currency of the underlying assets. For example: Assume a fund that invest in Japanese Assets that trade in JPY. Assume the base currency of the fund is USD and the trading currency is GBP. Assume a EUROpean buys the fund (by exchanging his Euro's to British pound and then buy the fund). The currency risk for the above is related to the evolution of the exchange rate JPY-EUR. The evolution of the exchange rates of GBP (trading currency) and USD (base currency) are immaterial to the currency risk that the investor from EUROpe runs.

Of course, if you bought in EUR, you won't get the same level of return (in EUR) as compared to the return in USD. For Example: take the db x-trackers II Barclays Global Aggregate Bond UCITS ETF 1C as an example: compare the graphs of performance in USD and performance in EUR the graphs are different but actually the fund (and the assets) are the same. The difference that you see in the graphs is only a representation of the change of the exchange rate over the last months.

Taxation of your investments

Every country has its own tax legislation. Cross-border taxation is determined by tax-treaties between the countries. Depending on the situation of the individual investor one can optimize the taxation. Sometimes countries allow to claim local tax credits for taxes paid in other countries, also based on the respective tax-treaties.

Kinds of taxation

Investors may face many different types of taxes on their investment, for example:

  • Tax on dividends received,
  • Tax on dividends accumulated inside a fund (and not received),
  • Tax on interest received,
  • Capital gains tax,
  • Wealth tax,
  • Transaction taxes (sometimes referred to as Tobin taxes),
  • Gift tax,
  • Inheritance tax,
  • Value-added tax,
  • ... and so on.

They may also be subject to more than one overlapping tax regime. For example national taxes, local or regional taxes, city taxes, and foreign taxes levied by the country of source of income might all apply at the same time. Investors need to find an efficient way through this maze of taxes. This is often not straightforward.

Levels of taxation

Investors that hold funds that hold securities are taxed at multiple levels.

  • Level 1: Taxation by the home country of the security.
    • The Level 1 taxes depend on the tax-treaties, if any, between the country of the asset and the country of the fund as well as the tax legislation in the country of the asset.
  • Level 2: Taxation by the country where the fund is domiciled.
    • The Level 2 taxes paid by the fund depend on the tax-treaties, if any, between the country of the fund and the country of the investor, and the tax laws in each country.
  • Level 3: Taxation by the home country of the investor.
    • The Level 3 taxes paid by the investor depend on the local tax laws in their country.
    • Sometimes countries allow investors to claim local tax credits for Level 2 and Level 1 taxes, also based on the respective tax-treaties.

Dividend taxation

Investors that hold funds that hold securities can be taxed on dividends by multiple countries at multiple levels.

Calculating dividend taxation as a ratio

There are 3 levels of dividend taxation to apply.

  • L1TW: Percentage of tax withholding by the home country of the security on the dividends distributed by the underlying international securities (Level 1).
  • L2TW: Percentage of tax withholding by the country where the fund is domiciled on the dividends distributed by the fund (Level 2).
  • L3T: Percentage of taxation that the individual investor needs to pay in his home country (Level 3).

The taxation to be withheld for Levels 1 and 2 can be calculated as a ratio:

Tax Withholding Ratio = (YIELD × L1TW) + ((YIELD × (1 - L1TW) - TER) × L2TW) The first term in parentheses calculates the Level 1 leakage. The second term uses the remaining dividend, deducts the fund's TER[note 3] then applies the individual's Level 2 tax to the remaining sum.

The main article contains detailed example calculations for both US and Ireland domiciled funds.

Aspects influencing the dividend taxation

  • For L1TW: taxation by the country of the asset:
    • The L1TW dividend taxes paid by the fund can be estimated using each fund's annual report, by dividing "Non-reclaimable withholding tax" by "Dividend Income".
  • For L2TW: taxation by the country of the fund:
    • If you are a US nonresident alien and invest in US domiciled funds or ETFs, and your country does not have a tax treaty with the US, there is a US dividend withholding tax of 30%. This reduces to 15% for residents of most treaty countries, and 10% for a few countries[2].
    • If you are investing in Ireland domiciled ETFs and you do not reside in Ireland, you do not have to pay any Irish tax withholding at the fund level[3].
    • In most countries, if your fund does not distribute the dividends but reinvests them immediately, no L2TW taxes are withheld.
  • For L3T: taxation by the country of the investor:
    • This dividend taxation can be a withholding tax, where the broker withholds the tax before paying the investor, or it can be a taxation in the yearly tax return based on the dividends declared.
    • Many countries will not have a L3T if there are no dividends paid to the investor.
    • Some countries will still tax the reinvested dividends. Reporting these reinvested dividends for tax can pose a real challenge. In these countries it can be easier not to use accumulating funds outside of tax-sheltered accounts.

Capital gains taxation

  • For Level 1:
    • Capital gains taxation on Level 1 depends on local tax legislation and tax treaties. There is often no Level 1 capital gains taxation for gains realised inside funds.
  • For Level 2:
    • US domiciled funds can distribute capital gains. This is not taxed by the US when paid to non-US investors.
    • Ireland domiciled ETFs are generally not required to make capital gains distributions. Capital gains accrued within the ETF accumulate, and are realised only when the investor sells ETF shares. These are not taxed by Ireland for non-Irish investors.
  • For Level 3:
    • Capital gains taxation on Level 3 depends on the local tax laws of the country of the investor.

Net total return vs. gross total return index

It is important to know that ETFs almost always track the net total return version of an index. From the MSCI website (MSCI is one of the most popular index providers) MSCI Index Definitions:

The MSCI Total Return Indices measure the price performance of markets with the income from constituent dividend payments. The MSCI Daily Total Return (DTR) Methodology reinvests an index constituent’s dividends at the close of trading on the day the security is quoted ex-dividend (the ex-date).

Two variants of MSCI Total Return Indices are calculated:

  • With Gross Dividends: Gross total return indices reinvest as much as possible of a company’s dividend distributions. The reinvested amount is equal to the total dividend amount distributed to persons residing in the country of the dividend-paying company. Gross total return indices do not, however, include any tax credits.
  • With Net Dividends: Net total return indices reinvest dividends after the deduction of withholding taxes, using (for international indices) a tax rate applicable to non-resident institutional investors who do not benefit from double taxation treaties.|MSCI}}

This means you can only earn the return of the net total return indices, which is the gross total return less dividend withholding tax.

Safe withdrawal rates across the globe

There are several studies related to safe withdrawal rates across the globe:

Securities lending

Securities lending is a common practice for institutional investors as well as commingled funds, mutual funds and exchange traded funds (ETFs), and these practices are strictly regulated in most financial markets. In a securities lending transaction, securities are temporarily transferred by one party (the lender) to another (the borrower). Securities lending may directly benefit shareholders, as it generates revenue for the fund which can offset fund expenses and improve index tracking. Please note that you as an ETF shareholder will only gain a portion of the securities lending income, the rest will go to the ETF provider. The exact ratio may vary by ETF provider. For example, the ETF provider could say that you as a shareholder will receive 50% of the securities lending income, and the remaining 50% will go to the fund provider.

Index tracking strategies : replication or synthetic

The index fund structure determines the strategy to track the index.

Full physical replication: the ETF buys and manages all the underlying constituent securities of that index – ie the ETF aims to hold every security the index at the appropriate weighting.

Some providers that aim for full replication but have minor differences in the statistical weightings of individual assets between the ETF’s basket and the index describe their replication methodology as sampling.

Physical replication with optimization: optimization involves only holding some of the underlying constituents of the index being tracked. Optimization methods are entirely model-driven, with a computer system making the buy and sell decisions. The ETF manager may use the physical replication with optimization if the index being tracked contains too many securities, and the ETF manager would like to reduce transaction costs.

Swap-based replication: Synthetic ETFs allow replication of the index using derivatives as opposed to owning the physical assets.

The most transparent and simplest to understand form of index tracking is the full physical replication.

Further considerations

Researching and comparing ETFs

Links to ETF screeners:

Some of the country pages in the Non-US domiciles in this wiki category contain sample portfolios or suggestions for (ETF) funds. While these can be taken to draft a first portfolio it is good to post a question on the forum as every country is different and the recommendation might change over time.

ETF trading volume

London Stock Exchange (LSE)

You can use LondonStockExchange.com to check for an ETF's trading volume the past 12-months or 30-days. Here is a link to the London Stock Exchange ETF Prices & Markets page. After you find the ETF of interest, navigate to its "Prices and trades" page to get the graphs and trading data.

The UK charges stamp duty of 0.5% on purchases of UK stocks. However, this tax does not apply to ETFs traded on the London Stock Exchange. ETFs are free of stamp duty when traded on secondary markets[4].

Swiss Exchange (SIX)

You can obtain an ETF's past daily trading volumes using the "Product Search" feature at the SIX Swiss Exchange website to search for a security's ticker/ISIN, then navigating to "Market Data" and clicking on "Historical values".

Notes

  1. For example, accumulated dividends are taxed annually in Germany, Switzerland and the UK.
  2. EUR= EURO
    GBP=British Pound
    CHF=Swiss Franc
  3. Some countries allow funds to subtract the fund's TER before paying the dividends, some don't. Please review the taxation of the country where the fund is domiciled

See also

References

Further reading

External links