Replacing distributing with capitalizing ETFs

For investors outside the US. Personal investments, personal finance, investing news and theory.
Sister forums: Canada, Spain (en español)
---------------
Post Reply
Topic Author
ruicarlov
Posts: 6
Joined: Mon Nov 11, 2013 6:13 am

Replacing distributing with capitalizing ETFs

Post by ruicarlov »

Hello everyone.
EU investor here.
Earlier this year I made my passive ETF portfolio following some recomendations on a local forum. However, I came to the conclusion that I was not being very effective tax-wise, since while I was using mostly low-cost ETFs (Vanguard), the double taxation of dividends is not pleasant at all. Plus, I believe capitalizing ETFs have interesting advantages, such as immediately revinesting dividends without the need for extra transactions on my part. They start generating compound gains from day 1.
The ETFs my possession that pay dividends are the following:

TLT - Barclays 20+ Year Treasury Bond Fund
TIP - Barclays TIPS Bond Fund
ITE - SPDR Barclays Capital Intermediate Term Treasury ETF
VNQ/VNGI - Vanguard REIT ETF/ Vanguard Global ex-U.S. Real Estate ETF
VBR – Vanguard Small-Cap Value ETF
VPL - Vanguard MSCI Pacific ETF
VGK - Vanguard MSCI Europe ETF
VWO - Vanguard MSCI Emerging Markets ETF

I've tried finding some alternatives, and to some extent I've suceeded. However, I still lack some critical analysis to see if they're worth it. Let's go by parts:

Small-Cap:
I've found one ETF that follows a US small cap index, the iShares MSCI USA Small Cap UCITSETF, with a 0.43 TER. The strange thing is it has a lot of different Tickers. There's CUSS, CSUSS and SXRG. The first two are for the London and Swiss stock exchanges, and they charts are nearly identical. However, for SXRG things are a little weirder. There are period where it overperforms the other two and others where it underperforms. Since the fund is supposedly the same, what's going on? I'm not even sure which one should I aim for.

Emerging Markets:
There are several options for this segment, however some of them have replication methods I've heard people don't like very much, such as "Synthetic-unfunded" from Amundi and Lyxor, so the ones I have in mind are:
SEMA iShares MSCI Emerging Markets UCITS ETF (Acc) TER 0.68%
DBX1 db x-trackers MSCI Emerging Markets Index UCITS ETF TER 0.65%
EMRG SPDR® MSCI Emerging Markets UCITS ETF TER 0.65%

SEMA and EMRG are closer to each other, while DBX1 has greater returns than the other on a 3-year basis, but smaller returns on a 1-year basis. Once again I'm kinda torn over which is a better option.

REIT:
Things are a bit different this time around, as I've only found one global REIT etf:
XGPD.L db x-trackers FTSE EPRA/NAREIT Global Real Estate UCITS ETF
This makes it a bit harder to compare to VNQ/VNQI, since it's a 2 in 1. I tried looking at FFR - FTSE EPRA/NAREIT Developed Markets Real Estate Index Fund to make a comparison, since it's also a global REIT fund.
XGPD behaves as expected, with higher NAV returns than FFR due to dividend accumulation. It should be a good alternative to VNQ/VNQI.

Europe:
This one isn't that hard, since it's playing for the home team. I've got these two lined up, since they have the highest market caps:
ERO SPDR® MSCI EuropeSM ETF TER 0.30%
SMEA iShares MSCI Europe UCITS ETF (Acc) TER 0.33%
On the long term, it seems ERO has a slight edge over SMEA, so maybe I'll go with that one.

Developed Markets (Asia, Pacific):
Now it starts to get trickier. I would have been fine with something like VEA - Vanguard FTSE Developed Markets ETF, which grouped Europe, Asia and Pacific, eliminating the need for a separate europe ETF. However, I've been unable to find anything. Same goes for developed Asia/Pacific. There's no good alternative for VPL. The best I could think of was to splice it even further. Since there are ETFs for Asia/Pacific ex.Japan and Japan only, I thought of using these two, in a 45%/55% allocation (since that's how VPL is allocated):
55% CPXJ.L iShares MSCI Pacific ex Japan UCITS ETF Acc TER 0.48%
45% SJPA.L iShares MSCI Japan UCITS ETF (Acc) TER 0.48%

Intermediate-term Treasuries:
Due to the lack of a good alternative to ITE, I followed a simillar logic. I found that ITE had 45% 1-3Year US Bonds and 55% 3-7 Year US bonds. By using these two ETF together I think it could replace ITE:
45% CBU3 iShares USD Government Bond 1-3 UCITS ETF (Acc) TER 0.23%
55% CBU7 iShares USD Government Bond 3-7 UCITS ETF (Acc) TER 0.23%

TIPS:
No direct alternative either. The best I could find was IGIL - iShares Global Inflation Linked Government Bond UCITS ETF. I'm not sure what the exact holdings are, but they seem to be majorly USA and UK TIPS. It's not identical to TIP, but it's highly correlated. It might do if there's nothing else.

Long term treasuries - I think there's no option but go with TLT. I haven't found any ETF AT ALL that is made of 20-year treasuries. If there's something I'm not aware of please let me know.
User avatar
Epsilon Delta
Posts: 8090
Joined: Thu Apr 28, 2011 7:00 pm

Re: Replacing distributing with capitalizing ETFs

Post by Epsilon Delta »

ruicarlov wrote: EU investor here.
This is about as useful an expression as "north American Investor".

You are a citizen of and taxed by a particular country. You are showing your parochialism by assuming that all 28 countries share the situation of your home country.
User avatar
Archie Sinclair
Posts: 413
Joined: Sun Mar 06, 2011 1:03 am

Re: Replacing distributing with capitalizing ETFs

Post by Archie Sinclair »

Epsilon Delta wrote:
ruicarlov wrote: EU investor here.
This is about as useful an expression as "north American Investor".

You are a citizen of and taxed by a particular country. You are showing your parochialism by assuming that all 28 countries share the situation of your home country.
That tone is not very nice.

ruicarlov, would you please tell us where in the EU you live and are taxed?
Easy Rhino
Posts: 3278
Joined: Sun Aug 05, 2007 11:13 am
Location: San Diego

Re: Replacing distributing with capitalizing ETFs

Post by Easy Rhino »

TIPS may be a little too us-specific for you anyway, what with being in an undisclosed european country and all.
Topic Author
ruicarlov
Posts: 6
Joined: Mon Nov 11, 2013 6:13 am

Re: Replacing distributing with capitalizing ETFs

Post by ruicarlov »

Ok, pherhaps I should have said eurozone country, namely Portugal. The truth is, even though the amount of tax may vary slightly from country to country, the main point I was trying to express was that all dividends received must pay taxes right away when you receive them, and there aren't any things like those tax-deferred accounts I see American people talking about here. That's why the dividend capitalizing ETFs may be a better option, according to the "EU investing" tab.
helfordpirate
Posts: 67
Joined: Sat Mar 23, 2013 12:04 pm

Re: Replacing distributing with capitalizing ETFs

Post by helfordpirate »

ruicarlov, I think you have a somewhat idealistic view of the level of tax harmonization in the EU!!

In the UK we do have tax deferred (SIPP) and tax "free" accounts (ISA) - however in the UK it makes no difference whether a fund or ETF distributes the dividend or immediately accumulates it. The holder is taxed on the income regardless. However, a synthetic ETF that tracks a total return index and reports no income in its accounts will effectively rollup the income tax free (obviously for a bigger capital gains tax bill later).

I would double check the case in Portugal before revising your portfolio as this treatment is not uncommon.
helfordpirate
Posts: 67
Joined: Sat Mar 23, 2013 12:04 pm

Re: Replacing distributing with capitalizing ETFs

Post by helfordpirate »

I should have pointed out that the "total return" indexes are calculated on the assumption of notional tax paid usually by a non-resident - so the benefit is not always what it seems!
Topic Author
ruicarlov
Posts: 6
Joined: Mon Nov 11, 2013 6:13 am

Re: Replacing distributing with capitalizing ETFs

Post by ruicarlov »

That's why I rephrased to eurozone in my 2nd post. I remember seeing something like that for the UK, which sets it a bit apart from Portugal, Spain, France, Italy, Netherlands, countries for which I've read some cases and came to the conlcusion that they worked in simillar molds, even if the tax values were different (in some cases went as low as 25%, while Portugal is 28%).

Of course that I know that I will have to pay taxes later on, when I sell some shares for rebalancing, for example. Still, that does at least have a small advantage, since there is a small compounding effect by not paying the taxes yearly. And the less money I have to reinvest manually, the less I suffer from bid/ask spreads.
U.S stocks/bonds aside, having ETFs from Vanguard has another big drawback, which is the double taxation of dividends. I always have to pay at least 15% os US taxes, plus the taxes of my own country. When we're talking about international assets, that makes no sense. Especially for the Europe section. EU ETFs with US assets have an implicit tax due to the double taxation, but they at least have the aforementioned compounding effect, which I believe can make a diference in the long term of a buy-and-hold strategy.
I believe there's also double taxation of dividends even for dividends coming from EU countries. There are of course the agreements for most countries, but honestly it's all a big mess, which involves a lot of paperwork and careful filling of tax forms if the broker I use is outside Portuguese territory (I plan to use Interactive Brokers UK), or I have to bear big transaction comissions and other costs with Portuguese brokers. Things are much simpler with capitalizing dividends, since the fiscal treatment of capital gains is simply 28% of what I earned, no matter where. Not headaches and possible losses with the dividend mumbo-jumbo.

Most of the capitalizing ETFs I mentioned are physical, since they're from iShares. They tend to use the optimized physical replication method. Since they're able to apply a tax treaty for a significant number of countries that way, even if they follow the total return indexes (which assume the worst-case scenarios), that actual situation has less taxes, and thus the tracking error is less than it would be expected.

What I mean to say is that my major question was not really if acumulating ETFs are better than distributing ETFs. While the rules may be different on the UK, southern european countries generally have it rough with dividends, and most of the time capitalizing is worth it. The main doubts I have are which of the ETFs I found seem better to you. More specifically: 1) what's the deal with the CUSS, CSUSS and SXRG, and their different behaviours;
2) why DBX1 (which is synthetic) behaves like I expected in the short term (more tracking error than Optimized replication ETFs SEMA and EMRG), but is able to give higher returns in 3-years (can a fund change a replication method midway thorugh its life?)
3) If splicing the intermediate treasuries and pacific markets like I did will allow me to "simulate" the behaviour of ITE and VPL, respectively.
Topic Author
ruicarlov
Posts: 6
Joined: Mon Nov 11, 2013 6:13 am

Re: Replacing distributing with capitalizing ETFs

Post by ruicarlov »

Okay, I think I finnaly started to understand the deal with SXRG and CSUSS. I didn't notice that the first was priced in euro and the second in USD. The diferences in performance most likely have to do with the EUR/USD pair.

However, the same reasoning can't be applied for the emerging markets ETFs, since the assets are not in the US, therefore their performance shouldn't matter if the ETF is in EUR or USD, right?
Post Reply