Vanguard S&P 500 ETF - New rating

Following a review of US equity ETF ratings, we have today awarded the Vanguard S&P 500 ETF a 3-star buy rating. As well as qualitative considerations, the review included a detailed quantitative assessment of overall costs to investors, both within the fund (internal costs) and in terms of gaining access to the fund (external costs). Summary charts are below – many investors will be surprised by the actual level of costs within these funds, of which US withholding tax on dividends is a major contributory factor. For internal and external costs, we found the Vanguard ETF to be very attractive compared to other available funds, with a low on-going cost (net of withholding tax) of just 9bp and a bid-offer spread of just 10bp. In particular, we note the speed with which the cost represented by the bid-offer spread has been reduced over the last 18 months as this fund has grown and become established in the UK and Europe. We have every reason to expect this spread will continue to tighten as this fund continues to attract fresh interest. As a result, we believe this fund is now considerably better placed than rivals who have previously relied on this liquidity gap to charge a premium.

The aim of this fund is to replicate the return of the S&P 500 index of US equities by holding all of the constituents of the underlying index in the same weights as the index. The fund uses full replication and does not engage in securities lending, meaning there is essentially no counter-party risk. We are also impressed by the US mutual structure to Vanguard, whereby the shareholders of Vanguard are investors in their underlying funds. This helps ensure that the interests of underlying investors and the Vanguard Board of Directors are very closely aligned, and one is not seen as a source of revenue for the other. We believe this set up is likely to see Vanguard continue to be a leader in driving price competition in the ETF industry as others are left to be reluctantly reactive.

Overall, we have no hesitation in awarding the Vanguard S&P 500 ETF (ticker: VUSA) a three-star rating, and adding it to our premier selection of rated funds.

Estimate of costs

Please see below our estimated internal and external costs. There has been much talk about the different factors that need to be accounted for when considering ETP costs, and the ‘Total Expense Ratios’ (TERs) reported by the ETP providers are just one factor to consider, albeit a major contributor.

Internal costs

We consider any systematic underperformance in the value of the fund relative to the index it is tracking to be a cost to the investor, and a cost that is internal to the fund (since it is related to the underlying value of the fund). There is a complicating factor in the form of US withholding tax, which is an unavoidable tax charged on dividends for overseas investors and acts as a cost to the ETFs. We therefore present two charge estimates – the first (first chart below) includes the effect of this tax, and measures performance against the Total Return Index. For reference, we also show what the index return would be if the ‘standard’ 30% tax was applied (this is the S&P 500 NR index and is determined by the index provider, not Bestinvest). We believe this is a fair comparison, as this tax is a cost to the investor, even though the money goes to the US treasury.

We also present a second chart with an estimate of the effective cost accounting for a 15% tax rate, which, due to tax efficiencies, is the effective tax rate paid by these ETFs. We include the Total Return and ‘Net Return’ index for comparison, though readers should note the Net Return index uses the full 30% tax rate rather than the real 15%.

External costs

In the final chart we show the change in the bid-offer spread over time. This is the difference between the buying and selling price for an ETF and represents a cost when investors buy or sell shares. Note that it is not feasible to add in costs such as brokerage fees, as these will vary based on the sums involved and commercial interests of individual brokers.