“In this world nothing can be said to be certain, except death and taxes.” - Benjamin Franklin
TAKEAWAY OF THE WEEK
Why US-listed ETFs are not necessarily cost efficient for you and me.
If you are like us, cost-conscious and a non-US person, US-listed ETFs are probably a bad idea. A caveat to this is that we are by no means tax experts, but we do understand the enormous effect of cost on investment returns. For this reason, tax cannot be ignored.
Yes, they are liquid, “cheap”, heavily marketed, used by robo-advisors all over the world, and in general great products...but not for non-US persons.
This may strike you as a surprise, but there are taxes that simply cannot be ignored, changing the “cost” quite drastically, especially when the ETF invests in non-US assets.
Let’s say you want to have exposure to emerging markets. The lowest cost, “cheapest” exposure you can get is Vanguard’s US-listed VWO, which has an expense ratio of 0.14%. VWO is so popular that it now has over US$80 billion in assets.
VWO also has a ~2.5% dividend yield, and therein lies the problem. As a Singapore or Hong Kong-based investor with no US tax treaty, there is a dividend withholding tax of 30% levied at the fund-level because it is a US-listed ETF, even though its underlying assets are not in the US.
Furthermore, if your country of residence does not have tax treaties with the underlying countries where these dividends are sourced, your effective dividend withholding tax could be even higher (underlying country tax plus the 30% US-imposed tax on top).
For reference, here is the list of countries that have tax treaties with Singapore and Hong Kong, which may only get your tax down to 30% in the best case.
The “cheap” 0.14% expense ratio ETF has now grown to a cost of at least >0.85%. This ETF has now become pricey.
That is not even the end of it. Let's say you are holding a basket of US-listed ETFs when you pass away. No matter where those ETFs were invested, your US-listed assets (ETFs included) would be legally subject to up to 40% draconian US estate tax. As an example, if you lived in Singapore and had $1,000,000 in a US-listed ETF that only invested in China, you would be liable to pay an estate tax of up to $400,000 to the US government. That does not seem right at all.
Thankfully there is a better way for us non-US persons to invest: UCITS.
UCITS (Undertakings for Collective Investments in Transferable Securities) began in 1985 as a regulatory framework to make cross boarding distribution of investment funds in the EU and beyond compliant, transparent, and with stronger protections for investors.
Today, there are thousands of UCITS funds listed by global fund managers such as Vanguard, Dimensional, Blackrock, PIMCO, etc., making their strategies available to global investors in a more tax efficient manner. Sticking with the emerging markets example, Vanguard’s emerging markets UCITS fund and ETF have a cost of 0.27% and 0.25% respectively. As compared to the US-listed ETF, they are far cheaper, taxes considered.
When investing in funds, there are three levels of taxes to consider:
Portfolio-level: this is tax due by the fund for holding, receiving dividends/income on the underlying securities. This is generally the same for UCITS and non-UCITS funds.
Fund-level: this is tax due by the investor to the fund depending on fund structure. For US-listed ETFs, this is 30% on income and dividends unless your country has a tax treaty with the US, which Singapore and Hong Kong do not. For Ireland UCITS funds and ETFs, this tax rate is zero.
Investor-level: this is dependent on each investor’s individual tax status, typically based on your country of residence. For those of us individual investors in Singapore, this is zero.
At the end of the day, it may be hard to avoid owning any US-listed securities in your portfolio. The US makes up over 50% of the MSCI All Countries World Index, which is one of the most widely used benchmarks for global equity portfolios. The liquidity and depth of the US market may trump the potentially onerous tax obligations, but there are alternative structures such as UCITS funds and ETFs that you can consider to get the exact same US exposure in a more tax efficient manner.
Tax, if not careful, can shoot low-cost investing in the foot.
You may be forgiven for not knowing about the implications of US withholding tax like so many others, but if some of your hard-earned savings are taken by the US tax authorities without you knowing it, then ignorance is definitely not bliss.