It’s hard to deny that passive investing, particularly using global equity trackers, is one of the best strategies you can follow. Some of my money is invested this way with the Vanguard All-World ETF. It’s not been without a few niggles, though.
While this blog mostly covers investment trusts, I also use it to flesh out my thinking on my own portfolio, hence this divergence from normal programming.
Why use a global tracker?
The idea behind using global trackers is relatively simple:
1. Shares offer the highest returns
Shares have produced the highest long-term returns of the major asset classes, although they can be volatile from year to year. Numerous studies from the likes of Barclays and CSFB have reams of data on this.
2. Diversify away from home
Equity returns vary significantly from country to country, so diversifying globally avoids the risk that you pick an underperforming country/region because of home bias.
The UK has the world’s third-biggest stock market, but it only accounts for about 5% of the total global market value.
3. Active funds underperform the market
The ‘average’ active fund is doomed to underperform the market due to costs. That’s because the sum of all active funds effectively is the market.
4. Trackers, on average, beat active funds
Trackers are cheap to run, as they don’t need expensive fund managers and they tend to trade less than active funds. They still tend to underperform the market by a small amount due to their costs, but not by as much as the average active fund.
(There’s a longer and more eloquent rationale for using global trackers on Monevator.)
Four things to consider
When you are looking at global trackers, I’d say that there are four main things to consider:
1. The size of the fund/reputation of the group
In other words, I want a fund that I think is going to stick around for the long term.
2. Do you want an open-ended fund or an ETF, or are you indifferent?
Platform costs are usually the key determinant here. Open-ended funds are usually cheaper to buy and sell but more expensive to hold. These costs vary a lot from provider to provider.
3. The proportion of the global market you want to track
Most global trackers are either developed markets only or they are developed and emerging markets.
Another common distinction is that some just track the largest stocks while others include small caps as well.
4. The charges it levies
Obviously, the cheaper the better. Trackers that cover emerging markets and/or small caps tend to be a little more expensive.
My road to VWRL
Back in 2013, when I was first looking for a global tracker, the choice seemed quite limited. From what I can recall, the Vanguard All-World ETF, or VWRL to its friends, was the standout option.
VWRL had been going for 18 months when I first bought it. However, Vanguard is one of the largest fund managers in the world and the inventor of the index fund. I felt pretty comfortable that this ETF was going to be around for at least as long as I was.
I preferred an ETF rather than an open-ended fund, as the platform charges were cheaper. I would have gone for a fund if needed.
VWRL uses the FTSE All-World Index. This “measures the market performance of large- and mid-capitalisation stocks of companies located around the world. It includes approximately 2,900 holdings in nearly 47 countries, including both developed and emerging markets. It covers more than 90% of the global investable market capitalisation.”
Its ongoing charges figure is currently 0.25% and I think it was the same when I first bought it.
A drawback with dividends
VWRL does have one disadvantage in that it pays out its quarterly dividends in US dollars. You normally lose a little cash when these are converted into pounds.
I’m charged 1% for foreign currency dividends and the yield on VWRL is typically around 2%. That effectively increases the cost of the fund to me from 0.25% to 0.27%.
There’s one further dividend-related drawback if you hold this ETF outside of an ISA or SIPP, as I do, but more on this later.
Building my global empire
I built up my VWRL position gradually between November 2013 and October 2015, with an average purchase cost of just over £40 a share.
My strategy at the time was highly sophisticated…
We’d just had our first child. Time was therefore in very short supply, so passive investing was highly appealing. Whenever the share price dropped back near £40 and I wasn’t drowning in nappies and baby sick, I topped up!
Indeed, looking back at the share price chart, it’s surprising to see that apart from one big spurt to £50 the share price of this ETF was essentially flat for three years from March 2013 to March 2016. So, I got the opportunity to top up a number of times.
More recently, a weaker pound and the strong-performing US market has driven the VWRL share price to around £65. And it’s paid around 2% in dividends each year as well.
As a quick and crude comparison, at the time of writing, VWRL had returned 83% over the last five years. Seven out of twenty trusts in the global sector for investment trusts beat that on a net asset value basis.
On a weighted average basis, the global investment trust sector has returned 95%. However, that percentage is boosted considerably by the fact that top-performer Scottish Mortgage accounts for one-third of the sector.
Would I go for the Vanguard All-World ETF today?
I’m not sure I would choose VWRL right now if I was picking a global equity tracker, but it would be on my short list.
According to Monevator’s list of cheapest trackers, there seem to be quite a few more options available now compared to 2013. That said, the cost difference isn’t that large for those that offer both developed and emerging markets as VWRL does.
For example, for our children’s Junior ISAs, I have gone with Fidelity Index World. This is a developed-market only tracker and charges just 0.12%. HSBC offers an open-ended fund with the developed/emerging combo for just 0.18%.
Emerging markets only account for around 10% of VWRL’s asset value. Therefore, one option to reduce my costs might be to put 90% in a developed-market tracker and then stick 10% in an emerging-markets tracker to go alongside it. Emerging-market trackers are available for around 0.2%.
Vanguard has launched a fund that tracks the FTSE Global All Cap index. This adds small caps to the mix as well. It covers 6,200 stocks compared to VWRL’s 3,200. The ongoing charge is about the same, at 0.24%, but it’s still quite a small fund with assets of just £120m. VWRL’s assets are around £2bn.
Irritatingly, though, I can see that the equivalent Vanguard ETF in the US is noticeably cheaper than VWRL. It costs just 0.09% and covers some 8,000 stocks compared to 3,200 for VWRL.
The perils of excess reportable income
The other dividend-related drawback I mentioned earlier arises because VWRL is an offshore fund (it is based in Ireland).
Unfortunately, this means we need to get into the weeds regarding the taxation of offshore funds.
Please bear in mind that I am not a tax expert. If you think this is something that might impact your own tax situation, it’s worth seeking professional advice.
If you hold a fund like this inside an ISA or SIPP then its offshore status shouldn’t be a problem. Outside of these tax shelters, it’s a different story.
Most offshore funds have what is known as UK reporting status. This is a good thing as it means that when you sell them, any profit you make is classed as a capital gain rather than income (the latter generally attracts a higher rate of tax).
But if the fund doesn’t distribute all the income it receives over the course a year then you may have to pay tax on what is known as ‘excess reportable income’ as well on any dividends you actually receive.
In other words, even though the fund in question didn’t pay out all this income, you are still deemed to have received it for tax purposes.
Here things can get tricky because excess reportable income generally doesn’t get included on the year-end tax certificates that brokers provide you with. You have to go the fund’s website and dig it out yourself.
Vanguard puts this information together on this page, although it was a lot harder to find a few years back.
A worked example
VWRL’s year-end is 30 June. It’s the number of shares you hold on the fund’s year-end date that determines your tax liability. The distribution date is 31 December, so that is when the excess reportable income is deemed to be paid.
Let’s assume I held 100 shares in VWRL on 30 June 2018 and then work through the specifics.
We can see from Vanguard’s report to participants for that year that we need to include an extra dividend of 4.42 US cents which is notionally paid out on 31 December 2018. This would, therefore, need including in a tax return for the year ended 5 April 2019.
You need to convert the dollar amount into pounds as well, using the exchange rate as of 31 December 2018.
I make the calculation: 100 * $0.0442 / 1.275 = £3.47.
VWRL’s total dividends for the year ended 30 June 2018 were $1.62 a share. So, the excess reportable income adds less than 3% to the total dividend amount.
Since I have owned VWRL the excess reportable income has ranged between zero and 8.05 cents. So, 4.42 cents is pretty typical.
I calculate that I have effectively lost in the region of 0.02% to 0.03% each year due to the tax payable on the excess reportable income for this particular ETF. The time I have had to spend getting on top of it all over the years has probably cost me considerably more.
There is one further detail to be aware of. Any excess reportable income you have reported can be added to your cost basis for capital gains tax purposes. This might reduce your capital gains liability when you sell.
Brokers should be doing more to help
Excess reportable income is a lot of bother for something that often seems to be pretty immaterial and gets netted off your cost base in the end anyway.
From the taxman’s viewpoint, I suppose the tax is collected earlier this way and usually at a higher rate. Presumably, it was set up to make sure high net worth individuals didn’t play fast and loose with offshore funds, but ordinary retail investors have got caught in the crossfire.
Apparently, there are moves to get brokers to include excess reportable income on their annual tax certificates but that seems to be a few years off still. It looks like we’re stuck with doing it ourselves for the time being.
I wasn’t aware of this when I first bought VWRL. Luckily, I found out about it before I needed to complete my subsequent tax returns.
Holding on, for now
I plan to stick with VWRL for a little while yet, although I might trim my holding at some point to make use of my annual capital gains allowance.
The dollar dividends and excess reportable income mean my effective cost for this fund is around 0.3% rather than the headline 0.25%, but I don’t think that merits a wholesale switch into another global tracker as that would entail some costs as well.
But my experience with this ETF highlights the fact that even passive investing can get complicated sometimes.
Please note that I may own some of the investments mentioned above and that you can see my current holdings on my portfolio page. Nothing in this article or on this website should be regarded as a buy or sell recommendation as this site is not authorised to give financial advice and I'm just a random person writing a blog in his spare time. Always do your own research and seek financial advice if necessary!
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