Vanguard Total International Stock Index Fund tax distributions

The Vanguard Total International Stock Index Fund is a very suitable candidate for placement in taxable accounts. The fund is now more attractive as a taxable holding since it is no longer structured as a fund of funds portfolio (which is ineligible for the foreign tax credit). As a fund now directly holding securities, the fund qualifies for the credit. The addition of an ETF shareclass to the fund in 2011 and the 2010 inclusion of the fund in the series of Vanguard Target Retirement Funds should help maintain the fund's overall tax efficiency.

The following tables provide long term data on the fund's history of both dividend and capital gains distributions. The first table also provides the historical distribution of qualified dividends and 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 following table provides a view of the fund's historical distributions expressed in terms of yields. We can see that the fund distributed modest levels of capital gains during its first five years of existence, but has not distributed a gain since 2001. Approximately 75% of dividend distributions have been qualified dividends, which under the current tax regime, are taxed at lower capital gains tax rates.


 * FY 1996 - annualized dividends, fund inception.
 * FY 2000 - annualized dividends, fund changed fiscal years.
 * FY 2002 - MSCI transitions to "free-float" market weighting.
 * FY 2003 - Introduction of 2% transaction fee on redemptions of shares held < 2 mos.
 * FY 2008 - Fund begins transition from fund of funds to direct ownership of securities. Transition completed in March 2009.
 * FY 2010 - Fund introduces admiral shares with lower $10,000 minimum investment.

Accounting data
The accounting figures and associated ratios (tables 2 and 3) 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
The annual fund accounting figures show that the Vanguard Total International Index fund turnover ratio usually stays in single digits. The rise in turnover during fiscal years 2009 and 2010 was likely due to the fund's transformation over the period from a fund of funds into a fund directly holding securities, and during FY 2010 from its change of index benchmarks to the MSCI ACWI ex USA IMI Index which added allocations to the Canadian stock market and small cap stocks to the fund portfolio. The MSCI ACWI ex USA IMI Index, being a total market index, can be expected to exhibit low, single digit turnover in future years. This low turnover can be attributed to the fact that stock migration out of a total international market index can come in only two dimensions:
 * 1) An individual company goes bankrupt and is delisted from the stock exchange;
 * 2) An emerging market country is demoted from its status as an emerging market and is placed into a frontier market index.

Neither event is likely to generate large capital gains.

Shareholder turnover, revealed in the Redemptions/Average Net Assets (R/ANA) metric, shows that shareholders have historically turned over their holdings in the fund at 10%-20% annual rates, suggesting average holding periods of between five and ten years.

The fund has received net inflows every year of its history. The heavy inflows in FY 2010 partly reflect the policy decision to include the fund in the allocation of Vanguard Target Retirement funds. From 2010 onwards, the fund will receive inflows from investors adding to these fund of funds (the fund has always been a holding in some of the Vanguard Life Strategy funds). Assuming continual net investment in these retirement accumulation portfolios should result in the continuance of future net inflows into the fund.

A look at realized net gains/losses shows that the fund realized net losses during the 2000-2001 and 2008-2009 bear markets. These losses produced loss carryforwards. Low fund and shareholder turnover has retained most of these carryforward losses as offsets to potential future gains. The introduction of ETF shares to the fund should also help increase its future tax efficiency, as the fund sees an increase in its realization of in-kind redemption gains.

Table 3.

Turnover statistics
Reference article: Average net assets

Table 4.