Vanguard FTSE All-World ex-US Index Fund tax distributions

The Vanguard FTSE All-World ex-US Index Fund is a very suitable candidate for placement in taxable accounts. The fund is often recommended as a core holding in a simple three-fund or four-fund (Figure 1) portfolio. The fund is also used in combination with the Vanguard FTSE All-World ex-US Small-Cap Index Fund  for investors desiring to establish their own set allocations between international large cap and international small cap stocks.  The following tables provide long term data on the fund's history of both dividend and capital gains distributions. The first table also provides an estimate of the foreign tax credit. One should note that the fund has a fiscal year ending in October, so its reported distributions for a year reflect the prior year's December distribution of dividends and capital gains.

The second table provides a database of the fund's accounting figures: the annual level of realized and distributed gains; its level of unrealized gains and loss carryforwards; as well as the annual in-kind redemption gains the fund has realized. These figures highlight the level of a fund's tax liabilities.

Because both manager turnover of securities inside the portfolio and investor turnover of fund shares can affect the level of gains realization, a third table provides historical turnover ratios.

Distributions
The Vanguard FTSE All-World ex-US Index Fund has not distributed a capital gains distribution in its four year history. Approximately 75% of dividend distributions have been qualified dividends, which under the current tax regime, are taxed at lower capital gains tax rates.

2007 dividend annualized

Accounting data
The accounting figures and associated ratios (tables 3 and 4) can help one visualize some of the major determinants of a fund’s tendency to distribute taxable gains. These determining features include:

Turnover: The rate at which a fund manager sells securities within the fund has a major effect on potential gains realization. Single digit annual fund turnover percentages result in a low rate of realized gains. Similarly, fund shareholders' sales flows have major effects on a fund’s distribution tendencies. Net flows into the fund have the following effects:


 * 1) Constant inflows allow a fund manager to purchase a wide range of price lots for shares. The manager can select high basis shares when forced to sell a stock (this may realize a loss). The manager can also select low basis shares when redeeming a stock in-kind (a non-taxable transaction that can remove an unrealized gain out of the portfolio.) This redemption technique is primarily employed with institutional creation and redemption of ETF shares.  Net inflows mean that shareholders are not forcing the manager to liquidate assets (and realize gains or losses) in order to meet redemptions. Large outflows can force such liquidation.
 * 2) A large and growing net asset base serves to diffuse any realized capital gains across a large base of shareholders and reduces the per share gain distribution. Large outflows have the opposite effect; any gains realized are spread across a smaller asset base and result in higher per share distributed gains.

The level of unrealized gains and carryover realized losses in a fund: Index funds defer gains realization and often accumulate significant unrealized appreciation, which if distributed, would be taxed; thus the unrealized gain/loss figure shows the potential gain (or loss) that would be realized if the portfolio was to be entirely liquidated. Any loss carryovers a fund possesses can be used to offset future realized gains (carryovers have an eight year expiration period).

Fund analysis
As an index fund containing large and mid cap stocks, the Vanguard FTSE All-World ex-US Index Fund, has to date, as expected, realized low, primarily single digit turnover ratios. The FTSE All-World ex-US Index holds large and mid cap stocks across both developed and emerging markets. Stock migration out of the index can come in two dimensions:
 * 1) An individual company is reclassified as a small cap stock and is removed from the index;
 * 2) An emerging market country is reclassified as a frontier market and is removed from the index.

Shareholders have invested net inflows into the fund over its four year history. Shareholder turnover in mutual fund shares has settled into the 20% range, suggesting an average holding period of five years. ETF shareholders have been mostly accumulating holdings in the fund, as measured by the very low redemption to sales (R/S) ratio. The transaction and tax efficiencies provided by the ETF shares should continue to provide benefits for the fund.

The fund has netted realized losses over the last three years (see the tab tax attributes in the spreadsheet for the net loss figures). These losses have been netted during both the 2008 bear market and over the subsequent two years of positive returns. The losses accrue into an increasing loss carryforward.

Table 3.

Turnover
Reference article: Average net assets

Table 4.

Tax rates
Mutual fund distributions will be taxed according to the tax laws governing the investment over the holding period of the investment, which are subject to change. The actual tax imposed will depend upon each individual's tax rate and the timing of purchases and sales. The federal tax rates applicable to mutual fund distributions and investor sales of securities for the period 2008 - 2012 are outlined below. Keep in mind that investment income may also be subject to state and local taxation.
 * 1) Short-term capital gains distributions are made from realized gains on securities held for one year or less. Short-term gains are taxed at ordinary income tax rates up to 35%. Mutual fund short-term gain distributions are included in a fund's ordinary dividend distribution; therefore, capital losses may not be subtracted from these distributions when computing taxes.
 * 2) Long-term capital gains distributions are made from realized gains on securities held for more than one year. Long-term gains are taxed at 0% for taxpayers in the 10% and 15% tax brackets and at 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets. (These tax rates are mandated for 2008-2012.) They are reported on tax Schedule D along with any other capital gains, and can be reduced by capital losses.
 * 3) Qualified dividends are the ordinary dividends that are subject to the same 0% or 15% maximum tax rate that applies to net capital gain. They should be shown in box 1b of the Form 1099-DIV you receive. Qualified dividends are subject to the 15% rate if the regular tax rate that would apply is 25% or higher. If the regular tax rate that would apply is lower than 25%, qualified dividends are subject to the 0% rate.
 * 4) When you sell at a loss you will either offset capital gains which would have otherwise been taxed at your capital gains rate or you will offset income (up to $3,000 maximum per year) which would have otherwise been taxed at your marginal income tax rate, or both. If you offset capital gains that would have otherwise not been taxed at all (because your capital gains tax rate is 0%) then this part of the tax loss harvest may be an outright loss.