Seeking other opinions [NZ investor asset allocation]

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NZ_Investor
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Joined: Wed Jul 24, 2019 4:27 am

Seeking other opinions [NZ investor asset allocation]

Post by NZ_Investor » Thu Nov 07, 2019 1:26 am

As a New Zealand investor, we are tax disadvantaged when investing into foreign financial assets. If you don’t want to read through much of the middle paragraphs, here is a TLDR: Effective fee of 0.1% in NZX50, effective fee of ~1.2% in a 0.03% management fee Vanguard ETF. The question is, given this structure, should my portfolio have a disproportionate weight assigned to New Zealand (relative to global market cap), and if so, how much would be appropriate?

To start of I’d like to briefly go over the tax treatment of investing in New Zealand assets and in foreign assets. I will first cover dividend imputation, and the foreign investment fund tax (FIF).

Note: I use 100,000 NZD in my calculation examples.

Domestic investment tax treatment:

There is no capital gains tax unless you are deemed a trader. There is only tax on dividends, you pay your marginal income tax rate on dividends received, and also are given imputation credits. A imputation credit is worth 28%, hence you will get a tax rebate if your marginal rate is under 28%, are fully imputed if your marginal rate is 28%, and will pay 5% if you are at the top marginal rate of 33%.

Domestic PIE funds (mutual or index funds) will pay tax at the investors PIR rate, which is 28% for the top income tax bracket. Hence, in a PIE fund, which I will be investing in, dividends will be fully imputed. Which means, I don’t have to pay any tax on dividends, as the company has paid tax on their profits and it is fully imputed.

Foreign investment tax treatment:

If you have over NZD 50,000 invested in total (not including foreign PIE funds), in foreign investments, you will now pay tax under the FIF regime. Under NZD 50,000 you would only pay taxes on dividends, but remember there are no imputation credits here, and there is a tax treaty with the United States.

Under the FIF tax regime, there are two ways to calculate tax, the fair dividend rate (FDR) and the comparative value (CV). Under FDR the taxable income is deemed to be 5% of the opening value, plus a quick sale adjustment (for buying and selling within the year, I ignore this here). This is because New Zealand has dividend yields of roughly 5% and foreign companies pay less dividends relatively. The CV method has the taxable income as the return of that year, e.g. 18%, or 1%, and any negative returns will result in zero tax paid. An investor who owns these foreign investments directly, which I will, can choose between FDR and CV methods every year, paying up to 5% and down to 0% effectively. If investing through a foreign PIE Fund (think US500 index fund, provided in NZ), you will use your PIR tax rate which in this case is 28%, and more importantly, the foreign PIE must pay tax under the fair dividend rate method (FDR).

Since I will invest directly, my 33% marginal rate * 5% (FDR) is 1.65%, which is basically an unrealised capital gain every year. Now, there will be years where returns are below 5%, so this is lower.

I now go over the management fees.

The three main ways to invest in the NZX50 are one through Smartshares, which caps each company at 5% with a fee of 0.50%. Second, through AMP Capital which is weighted by market cap and charges a fee of 0.33% (0.10% by and sell fee, but I will ignore this here). Finally, Simplicity offer a NZ share fund which includes 49 companies, which is the NZX50 but excludes Skycity for ethical reasons, they charge a 0.1% fee with a NZD 30 annual fee. Simplicity is the better choice here in the limit that the 30 dollar fee becomes insignificant where AMP still dominates. Overall on the NZD 100,000 investment, an annual fee of NZD 130 is paid.

In total on NZD 100,000 invested in Simplicities NZ share fund a total fee of NZD 130 is paid. This is an effective fee of 0.13% per annum. Since there is no tax, due to full imputation since all three are PIE, this is the only cost to the New Zealand investment. Which in the limit as the NZD 30 becomes insignificant, is 0.10%

My foreign management fees are basically zero with vanguard, 0.03% for VTI for example. I personally will use a combination of VTI and VXUS.

To end:

Historically, foreign investments have had negative years 26.88% from 1925 to 2018 inclusive, and 6.45% of the time is between 0 and 5%, totalling that roughly 2/3 of the time you would pay tax under FDR and 1/3 under CV where the majority of these times no tax is paid. Remember tax is paid every year, and under these measures you do not pay tax on dividends, you are paying an unrealised capital gains tax effectively. 0.05 * 0.33 (FDR * marginal tax rate) = 1.65%. 1.65% * 2/3 = 1.1%. This effectively becomes 1.2% when considering the times returns are between 0 and 5% and the including Vanguard’s management fee.

NZD 1,200 tax paid on the NZD 100,000 foreign investment, compared to NZD 130 paid by investing in New Zealand shares.

So the story comes down to having a massive tax advantage to investing domestically. I haven’t included the broker fees or currency exchange fees, which for example through Stake, has no transaction fees, but a 70 basis point FX fee to deposit funds and to withdraw.

I want to invest in foreign stocks almost exclusively through VTI and VXUS. I am very much of the opinion of having a well diversified, by market cap, global equity portfolio. New Zealand is under 1% of the worlds total market cap, I have a high paying stable job here, live here, I do not want my investments here in New Zealand. But under the current investing environment, which is poor, here in NZ (high fees, FIF tax regime, lack of access to foreign investments) heavily pushes you towards an NZ portfolio. Do note, if this route is taken, investments in the Australian broad market ETF are also plausible, since FIF tax rules do not apply here.

Now here is where I seek other opinions. Would you personally, pay 1.2% in fees, for a global portfolio (still ignoring other direct and indirect fees to investing), and not invest domestically? Or would you bite the rope and just go with domestic exposure and hope things change in the future?

I have not said anything about past returns as they aren’t important here. But you are welcome to do whatever research you want. Here is one paper you may wish to read https://www.nzfc.ac.nz/archives/2014/pa ... /II-2b.pdf

Thanks for reading what I have had to say.

Valuethinker
Posts: 38981
Joined: Fri May 11, 2007 11:07 am

Re: Seeking other opinions [NZ investor asset allocation]

Post by Valuethinker » Thu Nov 07, 2019 7:34 am

You have to look at NZ 50 and ask yourself if you are comfortable with those exposures.

100k in ftse100 would be c 15k in BP plus Royal Dutch Shell, for example.

I would not want to have 100 per cent of my assets in TSX/SandP60 say (Toronto) and that's a lot bigger share of world market cap than New Zealand.

Would holding individual stocks get you round the tax problem? I could see trying to synthesize world index via holding 20 to 30 stocks.

Otherwise I'd want to be at least 40 per cent global stocks.

TedSwippet
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Location: UK

Re: Seeking other opinions [NZ investor asset allocation]

Post by TedSwippet » Thu Nov 07, 2019 7:44 am

NZ_Investor wrote:
Thu Nov 07, 2019 1:26 am
I want to invest in foreign stocks almost exclusively through VTI and VXUS.
Choosing these specific ETFs could be a bad move for you. New Zealand has no estate tax treaty with the US, meaning that you risk losing up to 40% of your investment in these ETFs to US estate tax above just a miserly $60k exemption, should the worst happen.

You can eliminate this US estate tax threat by using equivalent non-US domiciled funds and ETFs instead. Same underlying assets, just insulated from rapacious US estate taxes for US nonresident aliens.

More in this section of the wiki:

Outline of Non-US domiciles - Bogleheads

Topic Author
NZ_Investor
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Joined: Wed Jul 24, 2019 4:27 am

Re: Seeking other opinions [NZ investor asset allocation]

Post by NZ_Investor » Thu Nov 07, 2019 7:58 am

Valuethinker wrote:
Thu Nov 07, 2019 7:34 am
Would holding individual stocks get you round the tax problem? I could see trying to synthesize world index via holding 20 to 30 stocks.

Otherwise I'd want to be at least 40 per cent global stocks.
The FIF tax regime applies to any foreign shares, bonds, etc, excluding Australian shares (but not for example, VTS which is USA stock market but as an Australian etf), so you cannot synthesise to avoid taxes. I hate this tax law with a passion, give me a 50% long-term capital gains tax any day, that would not prevent compounding as heavily as unrealised capital gains.

There is some trade-off, I’m considering dropping VXUS, and replacing it with NZ and Australian ETFs for the tax advantage. I definitely want a global portfolio, but whether a 1.2% fee is worth it is an important question.

Topic Author
NZ_Investor
Posts: 4
Joined: Wed Jul 24, 2019 4:27 am

Re: Seeking other opinions [NZ investor asset allocation]

Post by NZ_Investor » Thu Nov 07, 2019 8:02 am

TedSwippet wrote:
Thu Nov 07, 2019 7:44 am
NZ_Investor wrote:
Thu Nov 07, 2019 1:26 am
I want to invest in foreign stocks almost exclusively through VTI and VXUS.
Choosing these specific ETFs could be a bad move for you. New Zealand has no estate tax treaty with the US, meaning that you risk losing up to 40% of your investment in these ETFs to US estate tax above just a miserly $60k exemption, should the worst happen.

You can eliminate this US estate tax threat by using equivalent non-US domiciled funds and ETFs instead. Same underlying assets, just insulated from rapacious US estate taxes for US nonresident aliens.

More in this section of the wiki:

Outline of Non-US domiciles - Bogleheads
Thanks, I had not thought about the estate tax. However, the estate tax will not sway me to hold a domestic domiciled fund since these are forced into using the FDR method, and will have a larger management fee, 0.34% for Smartshares US500 bring the total cost from 1.2% to 1.74% (0.28 PIR * 0.05 (FDR) + 0.34%).

TedSwippet
Posts: 2499
Joined: Mon Jun 04, 2007 4:19 pm
Location: UK

Re: Seeking other opinions [NZ investor asset allocation]

Post by TedSwippet » Thu Nov 07, 2019 8:32 am

NZ_Investor wrote:
Thu Nov 07, 2019 8:02 am
Thanks, I had not thought about the estate tax. However, the estate tax will not sway me to hold a domestic domiciled fund since these are forced into using the FDR method, and will have a larger management fee, 0.34% for Smartshares US500 bring the total cost from 1.2% to 1.74% (0.28 PIR * 0.05 (FDR) + 0.34%).
Okay. But what if you held VUSD? Ireland domiciled and so completely insulated from the IRS, and a 0.07% TER. VT's TER is 0.09%. And the difference in performance between VT and VOO (S&P 500 tracker) is negligible, so using VUSD in place of VT would be a fine substitute.

Would holding VUSD also let you avoid the FDR tax method?

Topic Author
NZ_Investor
Posts: 4
Joined: Wed Jul 24, 2019 4:27 am

Re: Seeking other opinions [NZ investor asset allocation]

Post by NZ_Investor » Thu Nov 07, 2019 8:28 pm

TedSwippet wrote:
Thu Nov 07, 2019 8:32 am
NZ_Investor wrote:
Thu Nov 07, 2019 8:02 am
Thanks, I had not thought about the estate tax. However, the estate tax will not sway me to hold a domestic domiciled fund since these are forced into using the FDR method, and will have a larger management fee, 0.34% for Smartshares US500 bring the total cost from 1.2% to 1.74% (0.28 PIR * 0.05 (FDR) + 0.34%).
Okay. But what if you held VUSD? Ireland domiciled and so completely insulated from the IRS, and a 0.07% TER. VT's TER is 0.09%. And the difference in performance between VT and VOO (S&P 500 tracker) is negligible, so using VUSD in place of VT would be a fine substitute.

Would holding VUSD also let you avoid the FDR tax method?
This would still be taxed under the FIF regime. The only exceptions (with a bit of hand-waving), are New Zealand shares and index on those shares, and Australian shares and index on those shares. Anything that contains or has units that track foreign shares, will have to use these different taxes.

I personally hate the tax regime, having a unrealised capital gains tax on foreign holdings, when our country is well under 1% of the total worlds market-capitalization is terrible.

andrew99999
Posts: 516
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Re: Seeking other opinions [NZ investor asset allocation]

Post by andrew99999 » Thu Nov 07, 2019 10:09 pm

1.2% is nothing to scoff at, but Australia has a similar result due to tax credits also, but in my opinion it would still not be worth the concentration risk of having a huge amount in home country equities.

For Australian equities, I don't like the concentration risk of over around 20-30% of equities, which for you might be 10% NZ and 15% Aus.
Vanguard Australia takes tax into account and uses 40% home country, so for you might translate to 15%/25%/60% NZ/Aus/Global, but I still think it's too much.
Also note that I don't think you are really diversifying a whole lot when you split between NZ and Aus as they will go down together so don't assume that its 3 separate markets just because it is written with 3 separate numbers, but any diversification is better than nothing.

It seems like it is the same decision as for an Aussie - how much concentration risk can you tolerate for the added returns.

One thing of note is, with Australian equities, the tax credit is partly priced-in, meaning when dividends are paid out, the share price drops on average more than the the dividend amount, eating into this tax benefit, so you are not actually getting the full amount of what it appears. In Australia it appears to be around 40-80% priced in, making it a much easier decision to not overweight Australian equities. It may be worth checking if you can find anything about this is the case in NZ.
PassiveInvestingAustralia.com

Valuethinker
Posts: 38981
Joined: Fri May 11, 2007 11:07 am

Re: Seeking other opinions [NZ investor asset allocation]

Post by Valuethinker » Fri Nov 08, 2019 4:34 am

NZ_Investor wrote:
Thu Nov 07, 2019 8:28 pm
TedSwippet wrote:
Thu Nov 07, 2019 8:32 am
NZ_Investor wrote:
Thu Nov 07, 2019 8:02 am
Thanks, I had not thought about the estate tax. However, the estate tax will not sway me to hold a domestic domiciled fund since these are forced into using the FDR method, and will have a larger management fee, 0.34% for Smartshares US500 bring the total cost from 1.2% to 1.74% (0.28 PIR * 0.05 (FDR) + 0.34%).
Okay. But what if you held VUSD? Ireland domiciled and so completely insulated from the IRS, and a 0.07% TER. VT's TER is 0.09%. And the difference in performance between VT and VOO (S&P 500 tracker) is negligible, so using VUSD in place of VT would be a fine substitute.

Would holding VUSD also let you avoid the FDR tax method?
This would still be taxed under the FIF regime. The only exceptions (with a bit of hand-waving), are New Zealand shares and index on those shares, and Australian shares and index on those shares. Anything that contains or has units that track foreign shares, will have to use these different taxes.

I personally hate the tax regime, having a unrealised capital gains tax on foreign holdings, when our country is well under 1% of the total worlds market-capitalization is terrible.
This begs for a synthetic solution.

Have they applied the same laws to derivatives which track the underlying index?

I'd suggest you buy the S&P500 future and a non-US index future. Or use call options. I think Americans call that index option a LEAP.

Or have they closed that one off, too?

Otherwise in your shoes I would diversify into Australia (it's not a very well diversified index, but it would be some diversification from just holding NZ stocks). {EDIT Andrew's comment above is better informed than mine].

If NZ issues inflation indexed debt, there is a part of me that thinks you should be say 60% in that. The tax law restricts risk taking so don't take risk.

Are personal pensions in NZ also so taxed? Can you diversify through those?

jw50
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Joined: Thu Jul 27, 2017 2:00 pm

Re: Seeking other opinions [NZ investor asset allocation]

Post by jw50 » Sat Nov 09, 2019 5:26 am

Hi NZ_Investor,

Fantastic break down of various tax and charges. Thank you.

Ex pat KIWI occasionally considered going home. NZ tax on foreign share holding essentially amounts to a tax on wealth. :oops:

I believe in the principal of diversification. Tax also alters behaviour; I suppose that is what its designed to do.

Therefore its not surprising property ownership (much more favourable tax treatment) seems to be the main investment vehicle, another avenue of diversification.

No easy solution.

Valuethinker
Posts: 38981
Joined: Fri May 11, 2007 11:07 am

Re: Seeking other opinions [NZ investor asset allocation]

Post by Valuethinker » Sat Nov 09, 2019 6:57 am

jw50 wrote:
Sat Nov 09, 2019 5:26 am
Hi NZ_Investor,

Fantastic break down of various tax and charges. Thank you.

Ex pat KIWI occasionally considered going home. NZ tax on foreign share holding essentially amounts to a tax on wealth. :oops:

I believe in the principal of diversification. Tax also alters behaviour; I suppose that is what its designed to do.

Therefore its not surprising property ownership (much more favourable tax treatment) seems to be the main investment vehicle, another avenue of diversification.

No easy solution.
Disastrous macroeconomic side effects.

Property crashes are far and away the leading cause of banking crises.

In a small country you want people to hold globally diversified portfolios.

If the terms of trade turn against you the presence of foreign assets is a significant stabilizer on consumption.

See any oil dependent state and its stabilisation fund.

vandefrosty
Posts: 3
Joined: Tue Apr 02, 2019 11:05 am

Re: Seeking other opinions [NZ investor asset allocation]

Post by vandefrosty » Thu Nov 14, 2019 1:27 pm

I read the parliamentary white paper that lead to the FIF regime in 2005. It was predicated on repairing the 'unfairness' imposed on all NZers when investors bought foreign shares, assuming their sole motivation was to avoid dividend taxes as foreign yields are typically lower and foreign gains (where the excess return pops up) aren't taxed. It was also considered an anti-avoidance measure because that foreign income obviously fell outside the NZ withholding regime, and relied on self-reporting in days before FATCA and CRS.

The likely stifling impact on diversification was recognised and celebrated; it was a highlight that "NZ's capital" could be retained for investment in New Zealand. Hooray! But with a small share market, a mum-and-dad investor base that never got its confidence back after the 1987 crash, and no cap gain tax on residential property, we all know which sector sucked in all that capital! The government at the time was also seduced by arguments of the finance industry that it was being disadvantaged; investors in their funds were taxed more harshly than individuals trading on their own account. This lead to the PIE regime, but also impacted on FIF.

So now for something actionable. After almost 15 years, it's clear that no government has the will to address this - investors are wealthy and 'need to pay their share' etc etc. So you're stuck paying tax on the foreign investments you really want, or you need to synthesize something. Have you considered a portfolio of NZ and especially Australian companies that span a varies of sectors and generate earnings from international operations? Banks, miners and energy companies are obvious, but a quick scan suggests the ASX is full of global companies. Depending on the size of your portfolio, you might choose a couple of companies in each sector to minimise company-risk. Also there are some domestic companies that have high exposure to global sentiment (ports, airports, airlines, tourism operators, etc).

It's not ideal, but this might fulfill most of your objectives outside of the FIF, and leave you with minimal tax on the sectors where FIF cannot be avoided.

Greg

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