Inside the new Vanguard ETFs

Vanguard Canada launched some new ETFs this week, and I spoke with managing director Atul Tiwari about the funds. Let’s take a closer look.

Cross-Canada coverage

The Vanguard FTSE Canada All Cap (VCN) expands on the older Vanguard FTSE Canada (VCE). While VCE holds 78 large-cap stocks, the new index includes 255 holdings and covers 96% of the Canadian equity market. That makes it roughly equivalent to the S&P/TSX Composite Index, which holds 234 companies and claims 95% coverage.

This is about as close as you can get to a total-market index in Canada: dig further and you run into serious liquidity problems with small, thinly traded stocks. “We started out with a very large universe and pared it back to a number we thought would be terrific,” Tiwari explains. “But once you get to the practical aspects it gets pretty tough. Our partners on the capital markets side, who are creating units and doing the market making, have to be comfortable they can find these securities. Obviously there’s a cost associated with that, and at some point it gets too unwieldy and it doesn’t make sense.”

With a management fee of just 0.12% (the MER will be a few basis points higher), VCN is now the cheapest broad-market Canadian equity index fund available.

USA all the way

The most significant of the new ETFs is the Vanguard U.S. Total Market (VUN), a long-awaited Canadian version of the Vanguard Total Stock Market (VTI), which holds about 3,500 stocks and blankets 99% of the US equity market. Vanguard’s initial launch in 2011 included a version of this fund with currency hedging (VUS), but this new ETF is not hedged to Canadian dollars.

VTI is a core holding in my Complete Couch Potato portfolio, but VUN may be a better alternative for most Canadians. While VTI’s annual fee is just 0.05% (compared with 0.17% for the two Canadian versions) it must be bought and sold in US dollars, which adds a significant cost. Even if you use Norbert’s gambit, you should expect to pay at least 0.20% to convert loonies to greenbacks, and if you’re accepting your brokerage’s normal foreign exchange rates—as many investors do—that cost can easily be 1.5% each way, which wipes out any advantage for VTI.

There are a couple of other factors to consider when deciding between VTI and VUN. The US-listed version is more tax-efficient in an RRSP, because it is not subject to withholding taxes: these would cause a drag of about 0.30% (based on a 2% yield). On the other hand, the Canadian-listed version is not vulnerable to US estate taxes, which may a boon for wealthy Canadians.

Smaller investors will also appreciate that Vanguard has set the unit price for VUN around $24, which makes it easier to buy small amounts and use DRIPs. (After the run-up in US markets, VTI now trades at a lofty $86 a share.)

Over the hedge

Also new on the menu is the Vanguard FTSE Developed ex North America (VDU), an unhedged version of Vanguard’s existing international equity fund (VEF).

Not long ago, index investors were asking why it was so hard to find an international equity ETF without currency hedging, but iShares changed that in April with launch of the iShares MSCI EAFE IMI (XEF). In doing so, they scooped Vanguard. “We definitely would have been out earlier with these unhedged products: we had them in our product plan from the start,” Tiwari says. “But we couldn’t actually come out with them because we knew we were transitioning out of the MSCI indexes. It wouldn’t have been right to launch them and then very quickly make the change in indexes. ”

Vanguard has also dropped the management fee on two existing ETFs. The cost of VEF has declined to 0.28% from 0.37%, while the Vanguard FTSE Emerging Markets (VEE) now charges 0.33%, down considerably from 0.49%. Tiwari says these fee reductions were the result of some growing economies of scale, and the new relationship with FTSE: Vanguard did promise that lower index licensing would be passed on to investors. But I can’t help but think  competition also played a role: iShares’ new international and emerging equity funds were launched with very low fees (0.30% and 0.35%, respectively) and it’s probably not a coincidence that Vanguard’s products are now two basis points cheaper.