Is Vanguard's New ETF the Only Index Fund You Need? transcript

So, Vanguard have just launched three new funds, and one of them, understandably, has got people pretty excited. VALL is the ETF version of Vanguard's FTSE Global All Cap Mutual Fund. I own that mutual fund version inside of my pension, my SIP, and I pay 0.23% a year for the privilege. [music] This new ETF that promises to do potentially the exact same thing costs just 0.07%. That's less [music] than a third of the price.

I think what's even more astounding is that this new ETF is half the price of Vanguard's most popular global VWRL and VWRP. And they track thousands less companies. So, I was on holiday when this news dropped. When I saw this, so many questions came to mind. First of all, and I think you'll agree most importantly, what we calling it? We calling it Val, or we calling it Val? I mean, each to their own, I guess. You can call it Barry, if you like.

I'm going to call it Val. But seriously, is this now the default global fund for UK investors? And how come Vanguard just all of a sudden offer so much more for so much less? I put those questions directly to Vanguard themselves, and today I'll show you what they said, and together we're going to work out if this new fund deserves your money. Please understand that this video is not investment advice. You should do your own research.

When investing, your capital is at risk as [music] well, and past performance doesn't guarantee future results. So, when a fund says it tracks the world, that can mean different things. Take VWRL and VWRP. So, they're just two versions of the same fund. One pays the dividends out to you, while the other automatically reinvests them. But both VWRL and VWRP track the FTSE All-World Index, which includes around 4,200 large and medium-sized companies across 45 different countries.

Whereas the FTSE Global All Cap, both the mutual fund and now this new ETF version, they track all of the same businesses as VWRP would, but they also track smaller cap or smaller businesses. Adding those smaller companies takes you from around 4,200 individual businesses to approximately 10,100. So, the first sensible question to ask yourself before you consider buying this fund is do I actually want those smaller companies in my portfolio?

This is an academic paper from 1981 by someone called Rolf Banz. It was work like this that helped establish what became known as the small cap premium or the size effect. Banz found that historically smaller American companies have produced higher returns than larger ones. One explanation as to why is because smaller businesses are less established and are more vulnerable to failing. So, investors in those smaller might demand or expect a higher return for owning them.

Expected is the keyword there though. It isn't guaranteed. Just because you take on more risk doesn't mean you're automatically guaranteed to get more reward. So, I ran some backtesting to see if this theory held up over different time periods and we looked at American small caps versus American large cap businesses from 1972 until today and we're focusing on America because that's where we have the data. Assuming that you invest $10,000 initially and then $100 every month which is inflation adjusting over the time period.

Small caps over that time period beat the US large caps by about 0.23% a year on an annualized return basis. Now, I know that doesn't really sound like much on an annual basis, but over that time period over decades, that would add up to a massive difference in your end portfolio value. But, is that extra return worth it to you for the potential risk that these companies might fail to deliver those returns? For example, since 2010, the picture is completely different.

This following line shows that the American large companies have comfortably outperformed the small caps for more than 15 years. So, the picture on if small caps outperform is a little bit mixed really. Depends on the time period that you look at. I think the good news or the bad news, depending on how you feel about small caps is even though there's thousands of them in this new ETF, they only make up around 10% of value in total.

So, small caps could have an incredible year or a shocking one. Their impact on your overall return will be really limited. Personally, I think a better way to think about this new ETF is that it's not really a heavy bet on small caps, but it is the purest expression of passive investing. God, I sound like a douche, don't I? Spent 3 weeks in California, not cut my hair or had a shave, and now I'm sat here going, "Purest expression." What I mean is, a fund like Val, what it promises to do is truly track the global stock market.

You know, it's as close to pure global exposure as you could possibly get. But, that small cap inclusion could be a boost on performance, it could be a drag. But, there is an important detail on that. Just because the index contains 10,100 companies does not mean that Val will buy 10,100 companies as well. The fund's prospectus says that Vanguard will track the index using a representative sample of its companies. What that translates to is Vanguard aren't going to buy every company on the list.

They'll buy what they think are enough of them to recreate the overall returns of the index without actually buying every single business. This is really common across the fund landscape, and fund providers do this essentially to help them reduce fees by helping reduce the amount of exposure they have to microtransactions across thousands of different businesses that don't actually drive returns in the index. Of course, the issue is if you don't perfectly replicate the index, you leave room for error.

Tracking error is called. So, any difference between what the index actually produces and then what the fund produces is that tracking error. And that's really what matters here, not how many companies they're actually buying, but is the sample of companies that Vanguard select enough to track the index properly? You can normally see how closely a fund has been tracking its index on the information page or with the key information document.

Here's Vanguard's existing global all cap mutual fund, and that owns around 7,500 of the 10,100 companies in the index. And these charts show that it still tracks the overall index very closely. But, at the time of recording this, Vanguard is not telling us how many companies Val actually owns. Is Is strange that Vanguard has launched a fund like this and isn't telling people what it's actually going to be buying. My take, and this is pure speculation on what might be happening here, is when a new fund launches and there's not much money going into it, it can be really inefficient to buy the whole list of companies that they're going to buy, the whole effective sample.

So, when the fund's starting out, they might just buy a couple of thousand really liquid positions to help keep the fees down because it's more efficient to do so as the fund reaches scale. Vanguard might begin with a smaller group of big stocks then and then add more holdings as money enters the fund. But not going to advertise up front that the fund is currently only buying a couple of thousand stocks as this might get people questioning what's going on.

And to be honest, even if right now it's only buying a few thousand companies while it ramps up to scale, it's still going to be incredibly diversified and it will probably still track the index fairly well. But my issue with this fund right now is that Vanguard has not published a portfolio at the time of recording this. So, I can't see how aggressively it's sampling the index. And because the fund has no track record because it's brand new, we also can't measure how closely that sample will follow the underlying index.

I wouldn't be surprised if Val ultimately owns fewer than the 7,500 companies that its mutual fund counterpart does because sampling might be one of the reasons or one of the ways that Vanguard is able to offer this fund so cheaply. State Street's IMID is Val's direct competitor and that owns around 4,957 of the 8,176 companies in its index. I asked Vanguard what allowed it to launch Val at just 0.07% and it pointed to the scale of its European business, which it stated lets it launch products more efficiently and at a lower cost.

So, no mention of sampling, which kind of raised two other questions for me. So, why is Val so much cheaper than the existing global all cap fund that I own and why is it half the price of VWRP, which doesn't even include those small caps, so should be cheaper because it's got less companies in it and should also benefit from the same scale of the European operation, right? Part of the answer may simply be the fund structure and where the costs of operating that fund sit.

So, the existing fund is an OEIC. So, the costs of handling money in and out of the fund sit within the fund itself. Whereas Val is an ETF traded on an exchange. So, some of the transaction costs there shift to brokers and market makers. And instead of showing up in the fund cost, they can show up in other areas, for example, dealing fees or bid-ask spreads. More on those in a minute, but I don't think that fully explains why Val is less than a third of the price of the original, does it?

But, it does probably explain some of the differences. The much harder to answer question is why is Val half the price of VWRP? We now live in a world where Vanguard charges you more to own fewer companies. Why not just cut the price of VWRP? It's by far the most popular fund that they operate, and it would be simpler for them to administer because it doesn't have the exposure to all those thousands of small companies.

Research from Barron's gives us a pretty compelling answer to this. Vanguard recently reduced the fee on VWRP and VWRL from 0.19% to 0.14%. Those two versions of the same fund generate about 37.8% of Vanguard's ETF business that applies to the UK market. And just three funds, three in total, account for roughly two-thirds of Vanguard's European ETF revenue. VWRP and VWRL are Vanguard's European cash cows. Halving the fee again on these would wipe out tens of millions of euros every single year instantly.

Launching Val has allowed to do something quite clever, really. So, they can compete with this new wave of ultra-cheap funds from competitors. They get to get everyone talking online about how incredible this fund is, and it is incredible, really. A 0.07% product fee on this type of coverage. They then also don't have to halve the revenue of the enormous fund, the one that makes most of their money, which most of their clients already own.

I asked Vanguard directly whether it was concerned about investors migrating from the older funds into VAL. They said, "By expanding our global equity offering, we are providing investors with greater choice to meet their individual needs and preferences." Didn't really answer the question there, did they? Pure speculation on my part again. I just think this ETF allows them to capture people that were migrating away from Vanguard products for ultra cheap products elsewhere because they were so price sensitive, whilst also continuing to generate the revenues from their flagship product for people who can't be asked to move because, you know, they just want to stay where they are, or they don't want that small cap exposure.

I did ask Vanguard why VWRP is significantly more expensive than a fund that is ultimately more complicated. And this is what they said. "Both ETFs are competitively priced within their respective categories. While fee is an important consideration, the total cost of ownership extends beyond the OCF alone. Investors should also consider factors such as trading costs, liquidity, bid-ask spreads, and index exposure. The Vanguard FTSE All-World UCITS ETF benefits from significant scale and strong liquidity, which contribute to its overall value proposition." Now, that is a good answer.

And this is a point that we really need to consider because it could, in theory, essentially wipe out any of the savings from that fee reduction. Let's just dig into this a little bit. The bid-ask spread is the gap between the price at which you can buy an ETF and the price at which you can sell it. That difference is essentially a fee that you pay for buying and selling. A bigger, well-established fund, like VWRP, should have a smaller or tighter spread than a brand new fund with less money in it, like VAL.

I checked the live prices across several different investment platforms at the time of recording this to measure the spread. The numbers vary depending on the broker, but VAL's spread across the board is anywhere from two times to 9.5 times bigger than VWRP's. That is big. But on a £1,000 investment, we're still talking a difference here, or a cost to you, measured in pennies, or potentially a couple of pounds. But it does support Vanguard's point, really, that for now, VAL is more expensive to trade.

So, does Val's wider spread eliminate the savings that you make from the reduced fee? Versus say VWRP or VWRL. So, I ran the calculations and what it shows is that Val would recover its additional trading costs in somewhere between 7 months and 3 and 1/2 years depending on which platform you use. First of all, this highlights just how important it is that you pick the right investing platform to buy these ETFs on in the first place.

I list all of the brokers that I use below for you, including any sign-up bonuses. Some of those are affiliate links, which means if you use the link, we both get something and I've marked if any of those are affiliate links. Before you let this spread thing worry you, it's probably a fairly harsh comparison because if Val attracts more money and, you know, I think it will, its spread could be considerably smaller by the time you eventually sell.

I imagine it will tighten as the funds get more popular. But for someone who plans to trade a lot or invest small amounts on a platform with dealing fees and a wide spread, those additional costs could matter far more than the difference between the 0.07% and 0.14%. The whole spread thing doesn't mean you shouldn't buy Val. It means that the cheaper annual fee does not make you better off immediately. Really, when you're looking at fee differences on funds like this, it's holding it long-term anyway that's really going to drive the benefit of what is an amazingly low fee in this case.

Across the three examples, I've assumed that you start with a £10,000 initial investment, that you invest £200 a month, and that you get a 7% annual return over 30 years. We're assuming everything else is the same just to illustrate the impact of the fees. And those fees are 0.07%, which is the Val fee, 0.14%, and that's the fee for VWRP, and then 0.23%, which is the fee on the FTSE Global All Cap existing mutual fund.

Here's the total amount of fees that you pay over the period. But just look at the impact that those fees have on your final balance. Because don't forget, any fees that you've saved you could have invested and they could have continued to compound. And of course, the more you contribute, the bigger your balance, the higher these numbers will be. Quite clearly, fees are important, right? But I don't think it's the only thing you should consider when making this decision of if Val should become your investment of choice.

I think really it depends on a few factors. So, let me just run you through a few different scenarios here. Again, please understand that this is not investment advice. This is just how I think about this. So, for my personal circumstances, my SIP, my pension is my largest investment portfolio. And inside of that, I have the global all-cap fund, the original OEIC version. And for the privilege, I pay 0.23% across my other accounts, so my other like ISA, business investment accounts, I use funds that don't have the small-cap exposure.

But switching inside of my SIP looks like a no-brainer for me cuz it would essentially mean that I pay a third less fees. But Val is a brand new fund, and at the time of recording this, Vanguard has not told us how many companies it currently owns. And we don't know how closely its sample portfolio will track the actual index. The fact that this is Vanguard gives me confidence that this is a good product. And that alone, that reputation, might be enough for you just to invest your money immediately.

But my job is to scrutinize these platforms and these products. And if this was any other fund provider, let's just take Vanguard's name off the front of this thing, I would be sitting here saying, you know, I don't know what it invests in, and I don't know how it's going to perform, and I want to see that information before I buy it. I normally make my company pension contributions towards the end of the tax year anyway, so waiting suits me perfectly.

This idea of waiting kind of applies across all of the different scenarios that we're about to discuss, so just keep that in the back of your mind while we go through these. If I was starting a brand new global portfolio, Val looks extremely compelling. But you need to check how your platform treats ETFs versus OEICs. Some platforms charge different fee structures for the different types of investments, Hargreaves Lansdown being an example.

So, does it charge you a dealing fee? Can you automate regular investments? Can you buy fractional shares? These are all very platform specific questions. And again, those really apply to anyone. Okay, so what if you already own VWRP or VWRL inside of an ISA or a SIPP? Should you switch? Switching won't incur a taxable event because you're inside of a tax wrapper. So, you're going to avoid capital gains tax. So, that's not an issue.

But switching you might incur dealing fees and spreads and those things. But really, I don't think the fees are the question here. The question is, do you want the small cap exposure? As we've said before, you're changing from a fund that doesn't have it to one that does. So, you're changing your investment approach and you need to answer, do I want that? If you hold the funds you want to move from inside of a general investment account, really consider the tax position.

Because if you sell that fund, that is a taxable event. You could end up with a huge tax bill just to save a little bit on a fee. You could just use up your capital gains tax free allowance, which currently sits at £3,000 a year each year to to move that way. This level of consideration that people in general investment accounts need to make highlights the key point around this VWRP thing that I think Vanguard need to kind of address in a way.

For people who don't want to move, or for people who can't move because of tax, or for people who don't want the small cap allocation, those smaller companies, they're now paying more to have less. They're essentially paying a premium to not be in the more complicated fund. But I'm not going to be a Debbie Downer on this. This is an exceptional fund from an amazing fund provider. But there's no prizes for being the first person into a new fund.

So, before I start pouring money into this thing, I want to see what it buys and how well it tracks the underlying index. Just to make sure that it is in fact top tier and not just a poor cover of the original. >> If you'll be my bodyguard, [music] I can be your long lost pal. >> [music] >> I can call you babe. Babe, when you call me, you can call me [music and singing] Al. You can call me Al. >> No, no, no, no.