Index Managed Funds and ETFs outside Superannuation

I've been asked recently about Vanguard and other index managed funds outside super so decided to collect my thoughts.  In principle this should also be applicable to self-managed superannuation funds, although the tax implications will be different.  This post will be focused on products available in Australia more than general strategy (keep in mind that process is often more important than product: saving 0.1% in fees is no help if your strategy is one that you find too stressful and can't maintain).

There are two main investment vehicles that can easily be used for index investing in shares.  The more traditional managed funds are purchased by applying to the fund manager.  Minimum investments vary - Vanguard and Colonial First State have a $5,000 minimum.  However both offer regular investment investment plans from $100 per month which can be particularly useful when starting investing.  There are still 'trading' costs in the buy-sell spread (of the order of 0.1-0.3%) so it's still probably worth sticking with a product for a number of years (if moving investments around regularly those costs will mount up).   Canadian couch potato points out that when our balance is small, our contributions will have much more impact than investment returns. So having investments that allow for easy regular contributions at a reasonable cost may indeed be a better option than targeting the lowest annual fees (through ETFs) when your balance is low (particularly given brokerage costs).

An Exchange Traded Fund (ETF) is basically a managed fund which trades like a share on the ASX. Typically ETFs have lower ongoing management costs than an equivalent standard managed fund but you do need to pay brokerage to purchase them, just like a share.  The ETFs that align with the investment approach I've been talking about are again Index Funds.  Index ETFs typically trade very close to their Net Asset Value (NAV), the price of the underlying shares or bonds in the index.

Exchange Traded Funds (ETFs) have been around for a while, slowly gaining in popularity in Australia since the launch of the ASX200 SPDR fund (STW) in August 2001.  iShares and Vanguard have increased the range of offerings substantially over the past few years.

For traditional 'unit trust' managed funds, Vanguard charge 0.9% p.a. for share-based and diversified index funds up to $50,000 (and 0.7-0.75% for cash and bond funds, although many would not choose to hold these or hedged international shares outside superannuation due to their relative tax inefficiency.  Edit 7/10/2013: Now down to 0.75% p.a. for Australian Shares also).  Some comparable (as well as a couple of extra) Colonial Wholesale investments are listed below (Note the Realindex and Multi-Index funds may not be as tax-efficient due to likely higher portfolio turnover and bond holdings respectively):

Fund	MER
Colonial First State Wholesale Index Australian Share	0.41%
Colonial First State Wholesale Index Australian Bond	0.41%
Colonial First State Wholesale Index Property Securities	0.41%
Colonial First State Wholesale Index Global Share	0.53%
Colonial First State Wholesale Index Global Share – Hedged	0.53%
Realindex Wholesale Australian Small Companies	0.86%
Realindex Wholesale Emerging Markets	0.94%
FirstChoice Wholesale Multi-Index Conservative	0.61%
FirstChoice Wholesale Multi-Index Diversified	0.65%
FirstChoice Wholesale Multi-Index Balanced	0.70%

ETFs will typically have lower fees still (but require brokerage to purchase).  Some 'core' ETFs that may be of interest for the sorts of portfolio strategies I've been discussing are tabulated below:

Australian Large-Cap Shares		MER
Vanguard® Australian Shares Index ETF	VAS	0.15%
SPDR® S&P®/ASX 200 Fund	STW	0.29%
iShares MSCI Australia 200	IOZ	0.19%

Overall Vanguard have the best-diversified ETFs that I can find with the lowest costs.  I would have used VAS myself except it didn't exist when I started investing in index funds.  Note that VAS covers closer to 300 stocks, rather than the ASX200.

Note that at least the Vanguard International funds below (and I think some of the iShares ones also) are cross-listed US funds. That's a big reason why they're so inexpensive but this means that there is some withholding tax from their distributions (that you can hopefully use as a tax offset at tax time) and there may be other tax implications for US residents.  The SPDR products are more expensive but do offer the US and the rest of the world in a single product, as well as a hedged currency version.

Global Large-Cap Shares		MER
SPDR® S&P® World ex Australia Fund	WXOZ	0.42%
SPDR® S&P® World ex Australia (Hedged) Fund	WXHG	0.48%
or approximately split into US/non-US
Vanguard® US Total Market Shares Index ETF	VTS	0.05%
Vanguard® All-World ex-US Shares Index ETF	VEU	0.15%
iShares Core S&P 500 ETF	IVV	0.07%
iShares MSCI EAFE ETF	IVE	0.34%

I'm personally wary of Australian Small-Cap without some control for 'value' due to the weighting towards smaller mining and mining services companies, but this may not be entirely rational

Australian Small-Cap Shares		MER
Vanguard® MSCI Australian Small Companies Index ETF	VSO	0.30%
SPDR® S&P®/ASX Small Ordinaries Fund	SSO	0.50%
iShares S&P/ASX Small Ordinaries	ISO	0.55%

Australian Listed Property		MER
Vanguard® Australian Property Securities Index ETF	VAP	0.25%
SPDR® S&P®/ASX 200 Listed Property Fund	SLF	0.40%

As mentioned above, Bonds may be more suitable to hold in Superannuation depending on your specific taxation circumstances

Australian Bonds		MER
Vanguard® Australian Fixed Interest Index ETF	VAF	0.20%
Vanguard® Australian Government Bond Index ETF	VGB	0.20%
iShares UBS Composite Bond	IAF	0.24%
iShares UBS Government Inflation	ILB	0.26%
iShares UBS Treasury	IGB	0.26%
SPDR® S&P®/ASX Australian Bond Fund	BOND	0.24%
SPDR® S&P®/ASX Australian Government Bond Fund	GOVT	0.22%
Russell Australian Government Bond ETF	RGB	0.24%
Russell Australian Semi-Government Bond ETF	RSM	0.26%
Russell Australian Select Corporate Bond ETF	RCB	0.28%

Those cover the major asset classes. While there are many other ETF options available, some more specialised ones that I am reviewing for my own use are below.  If the paragraph explaining below makes no sense, I'd skip these funds and stick to the major asset classes.

iShares: Small-Cap US and Emerging Markets		MER
iShares Core S&P Small-Cap ETF	IJR	0.17%
iShares Russell 2000 ETF	IRU	0.24%
iShares MSCI Emerging Markets ETF	IEM	0.69%

Value-Tilted and Fundamental Index Funds
BetaShares FTSE RAFI Australia 200 ETF	QOZ	0.30%
Russell Australia Value ETF	RVL	0.34%

These ETFs cover segments and 'tilt' that is often more challenging to find in low cost index funds and Superannuation in Australia. Unfortunately we don't yet have access to the breadth of products available in the US. If you have been reading about Asset Allocation you might have come across the "Three Factor Model".  You might also notice that there's very little in the way of International Small-Capitalisation exposure. While there aren't general International Small-Cap index ETFs available in Australia yet we can at least get access to US Small-Cap indices (both the S&P and the Russell 2000).  Similarly there aren't many options to get access to 'value' tilted index funds.  I'm not sure either the BetaShares or Russell fund are perfect from this perspective but they are at least low cost.  Note that the Russell fund only holds a subset of the ASX, so may experience more turnover (and hence distribute more capital gains when it comes to tax time) than a pure capitalisation-based index fund tracking the ASX200 or the entire Australian stock market.

As always, I appreciate any comments.  And if you've found other low-priced index funds available in Australia, let us know.

Discosure: the author has holdings in VTS, VEU, STW and RVL.

Links:
Vanguard ETFs
Vanguard Retail Managed Funds (<$500,000)
State Street Global Advisors ETFs
iShares ETFs
Colonial First State 'Wholesale Investments'
Tips for trading ETFs
Choosing between ETFs and traditional index funds
Vanguard paper on home bias

19/09/2013 Additional Note: Regarding the cross-listed US funds I recently emailed Vanguard about VEU "Vanguard® All-World ex-US Shares Index ETF".  The fund is US-listed but receives dividends from other countries.  Some of those countries apply their own withholding taxes.  I'm told US taxpayers are able to take these into account as tax credits but Australian resident taxpayers are only able to take into account the US withholding tax (so this shouldn't be a problem for VTS and other funds with US companies).  While the headline Management Expense Ratio is lower than most Australian domiciled funds with International Shares, some of that benefit may be lost by taxation.

A back of the envelope calculation I did for my own benefit: if we expect around 2% p.a. in dividends then at a withholding tax rate of 15% we'd lose 0.3% while with 30% withholding it would be 0.6%.  If this is half our International Shares exposure (with the other half in the US) then we're talking 0.15%-0.3% difference which is less or about the same as the fee difference (50% VTS/50% VEU would have an average MER of 0.10% while WXOZ has an MER of 0.42% for a 0.32% fee difference).  Depending on the dividend distribution it may even be that WXOZ has a slight edge at times when it comes to the combination of fees and taxes, albeit without quite the level of diversification offered by the two Vanguard funds.  I suggest professional advice be sought on the taxation implications if you have any concerns about tax treatment.