If you’re an investor based in the UK, you’ve probably heard of Vanguard. They’re a hugely popular fund manager, and offer a slew of attractively priced, predominantly passive, funds for investors to choose from on their platform. But with so much choice comes some tricky decisions. Which fund, or funds, should you choose? Which is the best passive Vanguard index tracker fund for UK investors?
Let’s get one thing clear first. The term ‘best’ is useless when it comes to investing. ‘Best’ implies one fund is demonstrably better than another, which is impossible given nobody knows which funds will perform best ahead of time.
However, some funds do have advantages over others. This article takes a look at the benefits and drawbacks of each of the different funds available on Vanguard’s platform, measuring them against some standardised criteria, and providing some thoughts aimed at those investors looking to build their own portfolio on Vanguard’s platform.
This post focuses on Vanguard’s equity funds, and the follow up post ‘The best Vanguard bond funds for UK investors‘ compares Vanguard’s bond funds.
Vanguard’s equity funds
- Should I buy a FTSE 100 fund?
- Should I buy an S&P 500 fund?
- Which is the best global equity fund?
- Vanguard FTSE All-World UCITS ETF (VWRL) vs Vanguard FTSE Global All Cap Index Fund vs Vanguard LifeStrategy 100% Equity Fund
- ETFs vs Index Funds
- Active vs Passive
- Cost differences
- Benchmark comparison
- Performance comparison
- Hedging and currency risk
- Tracking error
- Share classes
- Structure/replication method
- UCITS compliance
- UK reporting status
- Fund sizes
- Securities lending
- Couldn’t I get the same global exposure cheaper by buying multiple funds?
- Summary: Which is best?
Best Vanguard equity index tracker funds for UK investors
Looking at the funds available on Vanguard’s platform, they offer several equity funds which they separate by region. We have the choice of 6 funds which invest in Europe, 6 which invest in the UK, 2 in Japan, 2 in Asia, 3 in the US, 4 in Emerging Markets, and 15 global funds. That totals 38 equity funds to choose from.
So which should an investor go for?
Should I buy a FTSE 100 fund? Or an S&P 500 fund?
A FTSE 100 fund is probably the first starting point for most UK investors thinking about constructing a portfolio. Most people in the UK have heard of the FTSE, and for those without much investing experience, it represents ‘The Market’.
Similarly for US investors, or UK investors who have done a bit more research into investing, the S&P 500 is often touted as the only equity exposure an investor needs. This view is advocated by the likes of Warren Buffett and John Bogle, both of whom are staunch believers in their mighty US of A. The bet on the US has proved incredibly profitable over the last 20 years, and those investors who have invested in the US have done extremely well. But is it sensible going forward?
Perhaps the first issue to consider is that by investing in either the FTSE 100 or the S&P 500 – or any single country for that matter – an investor is exposing themselves to several risks.
I’ve covered these risks in more detail in my series on diversification, primarily in the articles titled ‘How diversified is the FTSE 100?’ and the articles starting with ‘International diversification: The evidence – Part 1‘.
To save you a click, a summary of the articles is below. It covers the major drawbacks of investing in any single country. I’ve used the FTSE as an example, but the points are equally as valid when substituting ‘FTSE 100’ for ‘S&P 500’:
- By investing in only the FTSE 100, you’re not investing in companies outside the UK. By foregoing these companies, you’re taking on the risk that the UK’s stock market performs poorly.
In the fifty years to the end of 2011, the Italian stock market delivered an annual real return of -0.8% per year. That’s a negative real return over 50 years. By contrast, bonds returned 2.64% per year in real terms. Likewise, in Germany, equities rose 3.46% per year in real terms over the same time frame, again losing to bonds which returned 4.28% a year. And in Japan, the market still hasn’t recovered to reach its previous high in 1989.
We might reasonably believe that the UK market is always likely to avoid a long period of stagnation. The UK is a well-developed market, has a strong economy, corporate governance, regulations, and relatively free movement of labour and capital. But why take the risk?
By limiting your investments to one country, you’re running the risk that the country you invest in suffers the same fate of Italy, Germany, or Japan.
- By investing only in the UK, you’re also making some significant bets on which sectors will outperform. As technology companies only make up around 1% of the FTSE, you have almost no exposure to the technology sector. If you compare that to the technology sector weight in the MSCI ACWI at around 21%, that’s a significant underweight. In contrast, energy companies make up a relatively large 15% of the FTSE 100 versus around 4% for the MSCI ACWI.
If technology companies outperform and energy companies underperform, the FTSE 100 investor isn’t going to be very happy.
- Similarly, by only investing in companies in the UK, you’re excluding a huge number of other companies around the world. That’s important, because historically only 1% of stocks have created 99% of global wealth.
That’s an incredibly powerful statistic.
By only investing in one country, you’re greatly diminishing the chances that you’ll own those very few companies globally which generate the vast majority of long-term stock market returns. The best way to maximise your chances of having those 1% of stocks in your portfolio is to spread your bets as widely as possible. It’s extraordinarily unlikely they’ll all be based in one country.
Given that where a company is based is becoming increasingly irrelevant in a globalised economy, there’s little downside to owning companies from as many countries as you can.
- On top of all that, if you choose to invest only in the S&P 500, you’ve got currency risk to think about. It’s true that, in theory, currencies provide a long term expected return of zero. But by investing in the S&P only, you’re very exposed to the short-term movements between GBP and USD. This can make holding an S&P tracker difficult to stick with in times of sterling strength. After all, the best portfolio is one you can stick with.
Significant gains or losses resulting from currency movements can also increase the chances of investors attempting to dabble in one of the cardinal sins of investing – timing currencies. Please. Just don’t.
- Finally, while investing in only one country’s market is an increase in risk, it doesn’t come with a commensurate increase in return. You’re taking uncompensated risk – which is the kind of risk you never want to take. What’s more, it’s a kind of risk which can be easily mitigated through diversifying into other countries’ markets.
In fact, investing in other countries is actually likely to not only reduce risk, but increase returns. Better diversified portfolios increase long-term returns through minimising the volatility tax, and owning the few countries which drive the majority of long-term growth.
Overall, I’d argue that investing in only the FTSE 100, S&P 500, or any single market introduces a number of risks and reduces expected returns. Many of these risks are unnecessary for an investor to be taking, and can be easily ameliorated through the use of a more global equity fund.
Luckily, the decision to invest globally rather than into a single country narrows our search considerably. Vanguard offers several choices for investors looking for such a fund.
Which is the best global equity fund?
Now we’re getting somewhere.
There are three options for investors wanting to buy a global equity fund using Vanguard’s platform:
- The Vanguard FTSE All-World UCITS ETF (VWRL)
- The Vanguard FTSE Global All Cap Index Fund
- The Vanguard LifeStrategy 100% Equity Fund
Vanguard FTSE All-World UCITS ETF
Vanguard FTSE Global All Cap Index Fund
Vanguard LifeStrategy 100% Equity Fund
For ease of reference, the table below summarises each of the fund’s key features:
NB: Vanguard also offer an accumulation share class of the FTSE All-World ETF (the ticker is VWRP), but for some reason this share class is only offered on selected third party platforms, and not on the Vanguard platform itself. Worth bearing in mind if you’re not tied to their platform.
ETFs vs Index Funds
This is probably the most obvious distinction between the funds. The FTSE All World fund is an exchange-traded fund (ETF), and the Global All Cap fund and the LifeStrategy fund are both index funds.
Both ETFs and index funds aim to replicate the performance of an index. They are far more similar than they are different, and many people use the terms interchangeably. But there are a few differences between the two fund structures.
The main differences between an index fund and an ETF in general are:
- ETFs trade like stocks, in that investors can buy and sell shares throughout the day. Index funds trade once per day, after the market closes.
- ETFs tend to have lower minimums than index funds.
- ETFs are usually available on more third-party investment platforms than index funds.
- Because they tend to be traded via platforms, ETFs usually incur more costs in the form of broker commissions and bid-ask spreads than index funds (which are traded directly with the fund provider).
- ETFs can be traded using different execution methods (like limit orders).
- Index funds tend to be easier to make repeat investments into than ETFs (including dividend reinvestment plans).
When looking at these three funds specifically, the differences between an ETF and an index fund largely fall away.
The ability to trade intra-day using an ETF is an irrelevant benefit for any investor with a long-term time horizon (which should be all of us). The expense ratios are also almost identical – see the ‘Cost differences’ section below.
As this comparison is focussing on investors investing directly with Vanguard (and not via a third-party platform), the rest of the differences also disappear.
The minimum investment levels and reinvestment options are the same for all three funds. As Vanguard will be conducting the execution on your behalf, you don’t need to worry about the different execution methods. There’s also no trading commission on ETFs when using the Vanguard platform, and both ETFs and index funds are equally easy to make repeat investments into.
The fact that one fund is an ETF and the other two are index funds doesn’t make a great deal of difference for those investing via the Vanguard platform.
Active vs Passive
The Vanguard FTSE All-World UCITS ETF (VWRL) and the Vanguard FTSE Global All Cap Index Fund are both passive funds, but the Vanguard LifeStrategy Equity Fund is technically an active fund. Really, the Lifestrategy fund is an active ‘fund-of-funds’, as it only invests in other Vanguard funds.
I say the LifeStrategy is ‘technically’ active, because although the LifeStrategy fund only invests in other passive Vanguard funds, the fund manager is able to hold whatever weight they like in each of those passive funds. So it’s an active fund which uses passive vehicles. For example, about 20% of LifeStrategy is invested in the UK. Contrast this to the actual market cap weight of the UK at under 5% of the global market (MSCI ACWI). The fund clearly has a home bias in overweighting the UK, which is an active choice.
By choosing the Lifestrategy over the global all-cap, you’re making an active bet that the UK will outperform the rest of the world. Given that most passive investors tend to avoid making active decisions, with the belief that the market is, if not perfectly efficient, at least “efficient enough”, the global all-cap better reflects a passive investing methodology. Obviously nobody can know for sure whether the UK will outperform in the future, but the theory favoured by passive investors is that the market’s 5% weighting to the UK better reflects the UK’s expected returns than anything active investors could come up with (including allocating a 20% weighting to it, as in the Lifestrategy fund).
Whether you prefer active or passive is a personal choice. Regular readers of this blog will know where I sit. My arguments for favouring passive management can all be found in the ‘Active vs Passive’ section of this blog.
(NB: defining what counts as passive and what counts as active can be a tricky subject – which I’ve covered here.)
In summary, I’m an advocate for passive management because it:
- Has outperformed 90%+ of active managers
- Has lower fees
- Is more transparent
- Is simple and easy to understand
- Requires no forecasting
- Has no minimum investment requirements
- Has no capacity constraints
- Doesn’t require picking winning fund managers in advance
- Doesn’t require deciding whether to stick with underperforming managers
- Doesn’t incur the risk of a fund manager(s) having to suspend their fund or, worse, liquidate
- Has much lower levels of conflicting interests
- Becomes more powerful the more people adopt it
From an investing philosophy standpoint, and on the basis of all the evidence mentioned in the ‘Active vs Passive’ section, I prefer passive management over active. However, as far as active funds go, the LifeStrategy is about the most passive form of active management you can get.
In an ugly sister contest between all actively managed strategies, Vanguard’s Lifestrategy funds look like Margot Robbie.
On balance, as a proponent of passive management, I tend to prefer the passive FTSE All-World UCITS ETF (VWRL) and FTSE Global All Cap Index Fund over the more active LifeStrategy Equity Fund. Having said that, if you do want active exposure over passive, the LifeStrategy fund is an excellent choice.
Cost tends to be a major factor for most people when choosing between passive funds. After all, if you’re only paying for market exposure – which should be the same no matter which fund you use – why not pick the cheapest?
For this article, I’ve used what’s known as ‘MIFID II Total Cost of Ownership’ for each fund (aka the ‘TACO’ or ‘Total Annual Cost of Ownership’). Vanguard’s factsheets don’t display this number, but it can be found here. It differs from the traditional TER or OCF displayed on most factsheets as it also includes transaction costs for the funds, and any performance fees payable. It’s therefore a better measure of the total costs borne by the investor.
All three funds cost between 0.24% and 0.30%.
Are there cheaper options out there? Yes. You could get the same exposure at a lower cost by combining regional or country-level funds on Vanguard’s platform – see the ‘Couldn’t I get the same global exposure cheaper by buying multiple funds?’ section below. But for those who would rather hold a single fund and avoid the hassle and time of having to monitor fund weightings and think about rebalancing, these funds are about as cheap as you can get.
It’s true that fees are incredibly important in determining future returns. I’ve written a long post on the benefits of low fees here. But in reality, the gains are marginal once fees get this low. If your fund costs 0.30%, you’ve already gained much of the benefit of low fees. A move from a fund costing 2% to a fund costing 0.30% is a huge improvement, which can make a meaningful difference to your eventual portfolio size. A move from 0.30% to 0.10% is great, but nowhere near as meaningful.
This chart shows the huge impact of moving from a 2% fee to a 0.30% fee, with 5% gross returns assumed. Moving from 2% to 0.30% means ending up with a portfolio which is almost twice as large over 40 years. £1 grows to £3.26 with 2% fees, but grows to £6.28 with 0.30% fees – a massive 92% increase. It also shows that the move from 0.30% to 0.10% is much less important – a meagre 8% increase from £6.28 to £6.78.
Now, a difference of 8% after 40 years of compounded growth is still a large sum of money. All other things being equal, cheaper is usually better. Given that, shouldn’t you still be picking the cheapest of the three?
I’d suggest that when deciding between funds, a cost difference of 5-10 basis points is never going to be the deciding factor in whether or not you end up achieving whatever it is you’re investing for.
At this point, you’ve already won the ‘low cost’ game. That box has been ticked. Now it’s time to focus on the other areas of your portfolio or financial life which will end up having a much more significant impact on your portfolio.
Other factors, such as your spending habits, housing decisions, children, and choice of spouse will have a far larger impact on your eventual portfolio size than choosing between a fund which costs 0.25% and a fund which costs 0.30%.
That 8% increase we were talking about earlier by moving from 0.30% fees to 0.10% pales in comparison to getting divorced and seeing your wealth drop by 50% overnight, or to popping out another couple of kids and having them hoover up all your spare cash.
I doubt Homer Simpson was considering the cost differences between Vanguard funds when he complained:
“I have three kids and no money.
Why can’t I have no kids and three money?”
Ultimately, all three Vanguard funds are cheap enough, and the cost differences are small enough that they shouldn’t be a major factor in the decision to choose one over another.
The FTSE All-World ETF simply aims to track the FTSE All World Index as closely as possible, the FTSE Global All Cap aims to track the FTSE Global All Cap Index. The LifeStrategy has no benchmark.
Here’s a quick comparison of the two indices tracked by the two index-tracking funds:
The benchmarks for the two passive funds are almost identical. The most noticeable, but still fairly minor, difference is that the FTSE Global All Cap includes a 5% weighting to small cap stocks.
Although it has no benchmark, we can see the LifeStrategy’s objective on its factsheet:
- “The Fund gains exposure to shares by investing more than 90% of its assets in Vanguard passive funds that track an index.
- The Fund is actively managed in that the Investment Adviser has discretion in respect of the Associated Schemes in which the Fund may invest and the allocations to them, each of which may change over time.
- The Fund will have exposure to shares of UK companies and non-UK companies (including emerging markets). The UK will generally form one of the largest single country exposures for shares.
- The Fund attempts to remain fully invested and hold small amounts of cash except in extraordinary market, political or similar conditions where the Fund may temporarily depart from this investment policy.”
Aside from the UK bias, the objective sounds similar to the two index-tracking funds. As a result, the LifeStrategy fund is often used by UK investors to perform the same function in a portfolio as the index-tracking funds.
But what does all this mean for the performance for the three funds? Have the similar benchmarks for the two passive funds resulted in similar performance? And how about the un-benchmarked LifeStrategy?
The performance chart below shows the performance of the indices underlying the two index trackers against the unbenchmarked LifeStrategy fund since the earliest common inception date in 2011.
I’ve used the performance for the indices rather than the index tracking funds themselves, as the FTSE Global All Cap index fund has an inception date of 2016, but the benchmark it tracks has data stretching back further. So you can mentally knock off c. 0.30% from the indices’ performances if you’d like, but the conclusions remain the same.
As expected given the similarities in their composition, the first thing to notice is that the performance of the FTSE All World index and the FTSE Global All Cap index are almost identical. With a difference in cumulative performance of 4% over the last 9 years, the two indices are essentially indistinguishable.
The LifeStrategy fund has slightly underperformed the two index trackers. Differing performance is to be expected, given that the fund isn’t benchmarked, and currently has a 20% allocation to the UK.
Its underperformance is a result of its perennial home bias, given the performance of the UK market against the rest of the world over the last 9 years:
It’s fair to say that being overweight to the UK hasn’t felt great for UK-biased investors over the last 9 years.
2016 was an especially tough year for UK equities, as was the first 6 months of 2020. In 2016, the UK underperformed the MSCI ACWI by 13% – a 30% return for the ACWI in GBP, versus 17% for the FTSE All-Share. The first six months of 2020 were particularly brutal, with the FTSE falling 17% against the MSCI ACWI which was up 1%.
So the UK bias has definitely been a detractor from performance.
As well as the UK overweight, another factor contributing to the outperformance of the index trackers over the LifeStrategy has been the differing currency exposure.
Hedging and currency risk
Starting with the similarities between all three funds, they’re all unhedged. This means all three will be affected by currency fluctuations in the value of sterling. Particularly in the value of sterling versus the US dollar, given that the US makes up such a large portion of the global market.
However, the exposure to foreign currency risk differs between the two index trackers and the LifeStrategy fund.
Because the LifeStrategy fund has a higher weighting to the UK market than the other funds (a 20% weight versus a 5% weight), the LifeStrategy fund should be less affected by currency swings in the value of sterling than the other two funds.
UK-based companies tend to hedge their foreign currency exposure, as they don’t want to take currency risk any more than investors do. This overweight to the UK in the LifeStrategy fund therefore acts as a natural currency volatility dampener.
The LifeStrategy’s overweight to sterling will be additive to performance during periods of sterling strength, but will detract from performance during periods of sterling weakness.
For example, over the time period we compared performance for in the section above, sterling/dollar dropped from around 1.60 to 1.24.
This will have provided a sizable performance boost to any sterling investors holding foreign currency assets, and will have been a contributing factor in the outperformance of the index trackers (whose portfolios only hold 5% in sterling assets) versus the LifeStrategy (which is 20% sterling).
From a currency standpoint, all investors need to be aware of the effect FX fluctuations can have on their portfolio. Investors using the index trackers need to bear in mind that 95% of the portfolios are invested in non-sterling assets, so will be helped or hindered by foreign exchange movements to a higher degree than those investing in the LifeStrategy.
Currency exposure has proved to be a great help to sterling-based global investors over the last 9 years, but it won’t always be the case.
For those wanting to minimise the reliance the currency gods have over their portfolio, the LifeStrategy is the preferable option.
For my own personal portfolio, I opt for half my equity exposure in an unhedged global index tracker, with the other half in a hedged share class of the same fund. This means I don’t care about what happens to sterling, but still have a global, market-cap weighted portfolio.
Sadly Vanguard doesn’t offer a hedged global index tracker yet. However, as I was digging through Vanguard prospectuses on my weekend (who doesn’t?), page 121 yielded as exciting a find as you can expect from a 200 page document with such headings as ‘List of Depositary Sub-Delegates’ and ‘Auditing and Accounting Standards Risk’.
Under the list of different share classes for the Vanguard FTSE All World ETF, there are three lines for share classes which are listed as ‘Not yet launched’. One is a euro hedged share class, one is a dollar hedged class, and one is a sterling hedged class. So it seems like Vanguard has a hedged version of VWRL in the pipeline, for those who are keen to invest.
The results of comparing the index tracking funds against their benchmarks are pretty self-explanatory.
As you’d expect, both funds track their indices incredibly closely:
The LifeStrategy isn’t benchmarked, so we can’t judge it on tracking error. You could trawl through each of the underlying funds and measure their individual tracking errors, but I’m going to give Vanguard the benefit of the doubt on this one.
Both trackers do a pretty good job of tracking their indices, so there’s nothing to choose between them here.
The Vanguard FTSE All World ETF is only available on Vanguard’s platform in an income share class. The other two funds have the option of choosing between an income share class (income automatically paid out) and an accumulation share class (income automatically reinvested).
It’s worth noting that this doesn’t make a difference for tax purposes. Even if income is automatically reinvested via an accumulation share class, it’s still treated as reportable income as far as the taxman is concerned, and should be reported on your tax return accordingly. Obviously if you’re holding the funds in a tax wrapper, then you don’t need to worry about it.
The main advantage of accumulation share classes over income share classes is that you don’t need to bother with manually reinvesting the dividends. Holding income share classes means cash will build up in your account after each distribution is made by the fund, and you’ll need to go in and choose to reinvest it. Some platforms will charge you for setting up an automatic dividend reinvestment plan, but as far as I can tell Vanguard doesn’t offer this option anyway.
Accumulation share classes just save you a minor hassle. This is a slight advantage for the FTSE Global All Cap fund and the LifeStrategy fund, which offer the choice between accumulation or income classes, over the FTSE All World ETF which only offers income.
Structure and replication method
All three Vanguard funds use physical replication.
A physically replicated index tracking fund means the fund buys the underlying stocks in an index. For example, a physical ETF tracking the FTSE 100 would buy each of the 100 stocks in the FTSE 100 in line with their weightings. This is in contrast to a synthetic ETF which uses derivatives (usually swaps) to mimic the performance of an index without actually buying any of the index’s underlying stocks.
Both index trackers are physically replicated, as are the funds which the LifeStrategy fund invests into.
When tracking an index, physically replicated funds have the option to either buy all the stocks in an index – known as ‘full replication’, or buy a large enough sample of the stocks so that the performance is close enough – known as ‘sampling’. Sampling means funds don’t have to buy every single stock in an index, which minimises trading costs to the investor. It’s especially useful in markets where trading costs are higher due to illiquidity (such as in emerging markets).
Given that all three funds use physical replication with some sampling, there’s nothing to choose between them here.
All three funds are UCITS compliant.
UCITS is a regulatory framework which sets minimum standards for risk and fund management. These include holding a diversified portfolio, publishing clear guidance on their charges, and taking steps to safeguard investors’ money.
UCITS products are not necessarily safer, nor are non-UCITS products necessarily riskier, but if a product is not UCITS compliant then it may mean you need to conduct additional due diligence into the fund’s operations.
Thankfully, all three funds are UCITS compliant. However, that means there’s nothing to choose between them here either.
UK reporting status
First things first. I am NOT a tax adviser, tax expert, tax specialist, or any other form of authority on tax. None of this should be read as being advice, and you should always consult a professional tax adviser if you think this could impact your tax situation.
With that out of the way, we can now take a brief foray into the world of offshore funds. The FTSE All World ETF is an offshore domiciled fund, but the other two funds are domiciled in the UK.
The two UK domiciled funds are treated under standard UK tax rules (all income – whether distributed or accumulated is taxed as dividend income, gains at sale are taxed under capital gains). Offshore funds are treated slightly differently for tax purposes.
For those holding any of these three funds inside a tax wrapper, whether a fund is onshore or offshore makes no difference. However, for those investors holding them outside a tax wrapper, it’s worth noting that the offshore VWRL ETF has UK reporting status.
UK Reporting Fund status is a regime to combat perceived tax avoidance by UK investors investing in offshore funds.
UK individual investors in offshore funds are taxable on their investment gains at rates of either 20% or 45%. The lower tax rate is only available to individual investors in funds with UK reporting status.
A UK investor in a non-reporting fund must pay income tax on their realised gain at rates of up to 45%. However, in the case of a reporting fund, the gain on realisation is treated as a capital gain, taxable at a maximum rate of 20%.
The purpose of imposing income tax rates is to prevent UK investors accumulating income free of tax in an offshore fund, and then claiming capital gains tax treatment when they sell the fund.
If the offshore funds regime didn’t exist, UK investors could accumulate income offshore indefinitely and convert the income into capital when the funds are sold. The UK reporting status regime puts certain requirements in place for offshore funds and if they’re fulfilled, the investor will benefit from capital gains tax treatment at sale.
As the VWRL ETF has UK reporting status, it brings its tax treatment more into line with the other two funds. So that’s great if you’re investing into VWRL from outside a tax wrapper – it means you won’t get slapped with a huge 45% tax bill when you sell. However, given all three funds have similar tax treatment, it doesn’t help when trying to choose between them.
All three funds are of a large enough size that the funds’ sizes shouldn’t be a major deciding factor.
For the hardcore ETF nerds like myself, there’s an interesting article here about why even an ETF with a low AUM isn’t as much of a drawback as it might first appear. But that’s not a problem in this case – all three funds are large enough.
ETFs are able to generate revenue by lending out the securities they hold. The borrowers of the securities are usually short sellers, and pay a fee for being able to borrow the ETF’s stocks. The fee generated from lending is usually shared in some proportion between the ETF and the fund manager. The percentage of the securities lending revenue (SLR) which is returned to the ETF increases the fund’s returns, and the percentage of the revenue returned to the fund manager increases the manager’s profits, but isn’t a direct benefit to investors.
Lending does come with drawbacks, primarily the risk that the borrower isn’t able to return the stock (default risk). The higher the percentage of NAV lent out through securities lending, the higher the default risk.
Thankfully for those concerned about default risk, Vanguard is traditionally on the conservative end of securities lending. The only one of the three funds that engages in securities lending is the FTSE All-World ETF, which lends out 0.28% of the fund’s NAV. 94% of the SLR is returned to the fund, which adds an extra 0.01% onto the fund’s performance.
Although the VWRL fund does lend out securities, it’s to such a small extent that it should be barely considered a differentiator when trying to choose between the three funds.
Couldn’t I get the same global exposure cheaper by buying multiple funds?
It’s definitely possible to recreate global equity exposure using cheaper, regional funds.
If you have the time and energy, ultra-cheap global exposure using a combination of Vanguard funds offered on their platform is relatively straightforward.
You could combine the:
- FTSE Devleoped World ETF (VEVE) which costs 0.14%
- FTSE Emerging Markets ETF (VFEM) at 0.29%.
That would cost you about 0.16% in total if you invested into the funds in line with MSCI ACWI weights.
But you can do even better.
You could combine the:
- S&P 500 ETF (VUSA) at 0.08%
- FTSE Developed Europe ETF (VEUR) at 0.13%
- FTSE Japan ETF (VJPN) at 0.18%
- FTSE Developed Asia Pacific ex-Japan (VAPX) at 0.17%
- FTSE Emerging Markets ETF (VFM) at 0.29%
Investing into those in line with market weights would set you back roughly 0.12% per year.
So using only Vanguard’s funds, you reduce the cost down from the single fund’s cost of 0.24%-0.30% down to 0.12%. That’s a good saving.
But there are some drawbacks in striving for the cheapest possible portfolio.
There are no explicit transaction costs for trading ETFs on the Vanguard platform, but if you ever choose to move your portfolio to another platform (or aren’t constructing it on Vanguard’s platform), you’ll usually have to pay a fee for each ETF purchase and sale you make. More funds mean more transaction charges.
Even without paying transaction charges, you’ll always be paying a bid-ask spread on an ETF’s purchase or sale, as they’re traded on an exchange. The cost is usually small, especially on these large, liquid, ETFs, but it’s still a cost.
An additional, and in my mind more relevant, cost for a DIY investor putting together a portfolio with many funds is the time and energy it takes to maintain a multi-fund portfolio.
The ultra-cheap portfolio we just mentioned will contain 5 funds. Because the market weights of each region in the global market will drift with the region’s performance, the allocation to each of the 5 funds will need to change over time. For example, if the US performs well over time, the weight of the S&P 500 ETF in the portfolio will need to increase.
This means having to monitor the weights of each region in the MSCI ACWI, and ensuring your portfolio continues to reflect these weights.
Luckily the regional weights in the MSCI ACWI don’t change particularly quickly, but it’s still something to bear in mind. Passive investors, remember, don’t take active bets on which regions will outperform, so stick as closely as possible to the global market portfolio. The more the portfolio drifts away from the market weights, the more active the portfolio becomes.
Once you increase the complexity level and start introducing additional asset classes into your portfolio, then choosing to have more funds means another step up in portfolio administration. In order to maintain the desired asset allocation, you’ll not only need to keep the weights within the equity portion in line with the market, but you’ll have to make sure the split between the asset classes stays correct.
This means having to monitor the weight of each fund, the weights of each asset class, and it also means having to create some rules for when you’ll need to rebalance the portfolio. Once you’ve determined the rules, you’ll need to assess the fund weights and asset class weights against the rules to determine whether you need to rebalance or not.
That might be a price worth paying for those investors looking for the cheapest possible portfolio, but others might find the monitoring and rebalancing too onerous to be worth the cost saving.
I’ve deliberately avoided talking too much about tax in this article as everybody’s tax situation is different, and most people will be holding their portfolio inside a tax wrapper. However, for those investors holding a multi-fund portfolio outside of a tax wrapper, each sale of a fund which is required as a result of rebalancing may have capital gains tax consequences.
Whether or not you decide to reduce your portfolio’s cost by splitting the equity allocation into regional funds depends on how much time and mental energy you’re willing to devote to the portfolio.
For those wanting to minimise the costs as much as possible, the 5-fund portfolio gets your total costs down to an impressive 0.12%. For those looking for a balance between reduced cost, but only a minor increase in administration, splitting the equity exposure between the between developed and emerging markets funds might offer a healthy balance at 0.16%. For those who’d prefer the simplest approach with a ‘set-and-forget’ portfolio, the single fund solution would be the most appropriate, but comes at a higher cost of between 0.24% and 0.30%.
Summary: Which is best?
- Single-country funds, including funds investing in only the FTSE 100 or S&P 500, expose the investor to several unnecessary risks. Many of these risks can be ameliorated using global funds.
- Vanguard offer 3 global equity funds on their platform – the Vanguard FTSE All-World UCITS ETF (VWRL), the Vanguard FTSE Global All Cap Index Fund, and the Vanguard LifeStrategy 100% Equity Fund.
- Fund type. The fact that one fund is an ETF and the other two are index funds doesn’t make a great deal of difference. When investing via the Vanguard platform, almost all differences between the ETF and the index fund disappear.
- Cost. All three funds are cheap enough. The cost difference is 0.06% between the cheapest and most expensive, which is small enough that it shouldn’t be a major factor in the decision to choose one over another.
- Tracking error. Both index funds track their indices incredibly closely. While the LifeStrategy isn’t benchmarked, the underlying funds held by the LifeStrategy will show similar levels of tracking.
- Structure and replication method. All three funds use physical replication with sampling.
- Regulatory status. All three funds are UCITS compliant. The VWRL ETF, which is an offshore fund, has UK reporting status, so is taxed in a similar manner as the others, if held outside a tax wrapper.
- Size. Size doesn’t matter as much for ETFs, but all three funds are sufficiently large.
- Management style. The Vanguard FTSE All-World UCITS ETF (VWRL) and the Vanguard FTSE Global All Cap Index Fund are both passive funds, tracking the global equity market. The Vanguard LifeStrategy Equity Fund is an active fund-of-funds. It currently has a 20% weighting to the UK, versus 5% for the passive index trackers.
- Benchmarks. The benchmarks for the two passive funds are almost identical. The most noticeable difference is that the FTSE Global All Cap includes a 5% weighting to small cap stocks. The LifeStrategy fund has no benchmark.
- Performance. Despite the slightly higher weight to small cap stocks for the FTSE Global All Cap fund, the FTSE All World and the Global All Cap funds have performed almost identically. The LifeStrategy fund has underperformed them both, due to its overweight to the UK market and higher sterling exposure.
- Currency exposure. All three funds are unhedged, so all will be affected by currency fluctuations in the value of sterling. However, the two passive index trackers have over 95% of their portfolios in non-GBP assets, making them more sensitive to fluctuations in sterling than the LifeStrategy fund, which has around 20% invested in the UK.
- Share classes. The FTSE Global All Cap fund and the LifeStrategy fund both offer the choice between accumulation or income classes. The FTSE All World ETF only offers income. The two funds which offer accumulation share classes have a slight advantage in being able to save the minor hassle of having to manually reinvest dividends.
- Securities lending. Although the VWRL ETF does lend out securities, it’s to such a small extent (0.28% of NAV) that it makes little difference when trying to choose between the three funds.
In summary, all three are excellent funds. Ultimately, the decision of which of the three an investor should choose boils down to a few simple choices.
If you agree with the passive investing philosophy and want pure passive exposure to the global market, and don’t mind currency movements impacting returns, then either the Vanguard FTSE All-World UCITS ETF or the Vanguard FTSE Global All Cap Index Fund are fantastic choices. For those investors who don’t want to worry about manually reinvesting dividends, the Global All Cap fund is the way to go.
If you feel the need to dabble in active management, believe the UK will outperform, or don’t like the idea of taking that much currency risk in your portfolio, then the Vanguard LifeStrategy 100% Equity Fund is also a great choice.
For those investors who are serious about cutting costs, and have the time and energy to monitor and rebalance their equity content, then it is possible to replicate the exposure of the global index tracking funds using multiple, cheaper, funds.
For those who’d rather ‘set-and-forget’ by investing in one fund and not worrying about having to monitor and rebalance their portfolio, then any of the three single-fund options are still very strong.
Congratulations! As you’re now deciding on precisely which vehicle you’re going to use to achieve your low-cost, transparent, liquid, globally diversified equity exposure, you’ve already won the investing game.
At this point, all the options open to you are excellent, and the decision to choose one fund over another – or the decision to use multiple funds over a single fund – comes down to personal preference. There are no wrong choices.
If there’s one thing I’d like readers to take away from this post it’s this: Once you’ve made it to this decision, other factors, such as your spending habits, housing decisions, children, and choice of spouse will have a far larger impact on your eventual portfolio size than choosing between any of these funds. So make a decision you’ll be able to stick with, and devote your time and energy to other, higher impact areas.
Having written this post, some readers might be curious as to how I allocate my own equity exposure in my personal portfolio. In the interests of full transparency, I hold 50% of my equity exposure in an unhedged global index tracker, and 50% in a hedged global index tracker. My portfolio is funded automatically through monthly direct debits, and takes zero maintenance. I sleep safe in the knowledge that I don’t care about which stocks are outperforming, which managers are outperforming, which markets are outperforming, or how sterling is doing. It’s the ultimate ‘set-and-forget’ portfolio.
I’m now able devote more of my time to activities I enjoy, including writing 7,000 words on a topic whose conclusion is, “It doesn’t really matter”.