Question about FTSE All-share index trackers

isan00b90

I'm trying to decide between the HSBC one and the Vanguard one

I'm mostly looking at the TER as well as the tracking error.

I want to invest a monthly sum but I have a relatively low monthly budget (about £200-300 for now). I'm thinking because I have to go through a third party to buy the Vanguard the costs will eventually become too much, even though its TER is lower than the HSBC tracker? I can buy the tracker directly from HSBC whereas I'd have to go through a fund supermarket to get the Vanguard one, incurring more costs. (Note the Vanguard one also has a one of stamp duty fee of 0.5%)

Also, does the company you hold the tracker fund with trade the stocks you own, thus costing you money on top of the TER? (e.g. I'm aware that some companies charge you a fee for trading so would HSBC trade the stocks shifting the fee onto me?).

Thanks

bowlhead99

isan00b90 wrote: »

I'm thinking because I have to go through a third party to buy the Vanguard the costs will eventually become too much, even though it's TER is lower than the HSBC tracker? I can buy the tracker directly from HSBC whereas I'd have to go through a fund supermarket to get the Vanguard one, incurring more costs.

I think that's a red herring because HSBC's global investment centre also has a platform fee - 0.39%? You can find platforms cheaper than that to hold either HSBC or Vanguard. With Vanguard when you get to £100k you can go direct to them and skip the platform - though I appreciate that's some way off ...

(Note the Vanguard one also has a one of stamp duty fee of 0.5%)

The cost is unavoidable. The money doesn't line the manager's pocket - if you join or leave a fund, the fund incurs stamp duties and some other trading costs as people join or leave and the cash moves between investments or cash. What Vanguard do is package it up and charge it as a one off to the people who are joining. By the time you have been doing this for 5 years you may have £20k at work within your fund but as you are only buying £200 a month at that point, or even £nil, you will only be paying £1 a month of stamp, or even nil.

While at HSBC if they don't have the new joiners paying the stamp explicitly, all the fundholders, even the ones with £20k who are holding and not trading, will share the cost of all the stamp duties incurred that year. This cost to all holders will be seen as a tracking error as the costs mean they lag the index, and lag what you would have got as a buy-and-hold investor at Vanguard who didn't have to pay everybody else's stamp.

As an aside, Vanguard initial fee is 0.4% not 0.5% but the principle's the same.

Also, does the company you hold the tracker fund with trade the stocks you own, thus costing you money on top of the TER? (e.g. I'm aware that some companies charge you a fee for trading so would HSBC trade the stocks shifting the fee onto me?).

Not sure what you quite meant by this. Which companies charge you the fee for trading ? You mean when you buy a share in a company, you have to pay a broker for buying the shares in the market? That is true, the broker arranges the purchase and gets the shares registered into your name and you pay him some flat fee or percentage charge depending what broker you used.

When a fund buys shares in a company they also pay fees for the broker that arranges it for them. So when you and umpteen other people join the fund one day and deposit £1 million between you into the HSBC fund or the Vanguard fund, and those funds don't also have the same number of customers exiting their fund on the same day, they will be left with spare cash that needs to be put into investments. So they'll buy some more Shell shares and BP shares and Lloyds shares and Vodafone shares and so on in the right proportions, with the £1 million.

They might want to spend £30,000 on Shell shares because Shell is 3% of the index that day. But with broker/ custodian commissions, it might cost £30,030. Then some other point when you and the others want to leave, they sell them and only net 29,970 from selling 30,000 worth of shares. So they lose money on the trade even though the price didn't move. You may not see this total £60 specifically on its own going through the accounts and financial statements of the fund, because they are just wrapped up in the realised gains and losses on investments giving you a worse result than if the broker had done his work for free.

So, these costs are seen in the overall performance - they're not borne specifically by you but you will inherently be paying for it because their broker doesn't work for free and it's you and all the other unitholders who are bankrolling the fund.

They also need to buy or sell shares every so often when a new company joins or leaves the index. So if some company gets so small that they no longer qualify for the FTSE SmallCap, or just so small that they don't make a meaningful difference to the performance of the whole HSBC or Vanguard fund, they will just sell that company and buy whoever got promoted into the index - either a new IPO or a small company that grew a lot. Again, costs are incurred.

But the beauty of index investing is that they are not trading very often because companies don't join or leave the index very often and they are not making discretionary purchases from time to time, they have to follow the index. So the broker costs are going to be quite similar from one index fund to the next, unless one of the funds is growing or shrinking much more rapidly and needs to keep doing trades when people join and leave to convert cash to investments and vice versa.

Glen_Clark

bowlhead99 wrote: »

(stamp duty) cost is unavoidable..

But what about ETF's?
As I understand it the broker pays for them with shares he already owns and wants to dispose of, rather than cash which incurrs stamp duty.
When I have bought ETFs (through my X-O account) I have been very surprised how low the costs seem to be.
(I didn't record the figures, but I enter the bought shares into my excel spreadsheet which shows an immediate loss because of the trading costs, and the loss has always seemed much lower with ETFs than with shares)

bowlhead99

When new ETF units are created every so often - to avoid the premium that they would have to trade at if you and your friends wanted to buy them and nobody else wanted to sell them - the ETF issuer might want to get paid for the newly created units in cash, or he might prefer to receive a basket of shares that he wants to hold in the fund (in specie creation). So he can issue his units and receive shares in underlying companies, which is more efficient for him.

But he is still 'buying' the shares in the underlying companies like HSBC or Shell or whatever, whether he pays for them with cash to buy them on the market or whether the consideration for them is a new issue of his own units. As far as I know, stamp duty is payable either way.

In theory these creation costs could lead to a large bid-offer spread if the ETF is something obscure and is thinly traded. Because creation fees include transaction taxes like stamp duties (or their equivalent in other countries) among other things.

However something very liquid like an iShares tracker is going to have a lot of people buying and selling all the time so they don't actually need to create a lot of units (if any) if there isn't a huge buying pressure and trending growth in the investor base. When you buy 100 units and someone else sells their 100 units there's still the same number of units in issue ; no units need to be created or destroyed to manage the discount or premium. And there are still the same underlying shares in Shell and HSBC etc held, nothing is bought and so no stamp duty is paid by the ETF issuer.

So, for you as an investor buying in, you pay your offer price for the ETF and you pay your broker fee and you don't pay stamp duty on buying an ETF unit. You compare that to the bid price and you haven't lost much. Compared to buying an individual share of Shell or HSBC where you would have lost 0.5% stamp.

If you are not using a physically replicated index tracker (like ishares) but a synthetic one (like DB x-tracker), then the ETF manager/issuer doesn't try to acquire individual UK listed shares like Shell and HSBC anyway. If the ETF size needs to grow for the creation of another 50,000 units, he will not be getting individual stocks but just some more of the total return swap or whatever derivative instrument he is holding to create his virtual portfolio. Of course, there are costs and risks involved in holding an index as a synthetic, there's no such thing as a free lunch - although on the face of it they would seem to avoid stamp duty.

Bottom line, you can invest into ETFs quite cheaply as they are just baskets of shares and if the basket is not changing in size, there are no tax costs. At the start of this year, stamp duty was technically payable on buying shares in ETFs, but as none of them were UK domiciled, nobody ever did. The government has now officially waived stamp duty on UK domiciled ETFs to make the UK investment management industry more competitive, so somebody could start one if they wanted and its investors on the secondary market still wouldn't pay stamp duties. But this doesn't change the fact that the fund still pays all relevant transaction costs and duties on buying and selling, as far as I know.

On the Funds side (UTs and OEICs) the fund pays stamp duties when it buys shares in UK companies and it also historically paid a special SDRT "Schedule 19" when people redeemed out of a fund that held UK equities. As part of the 'UK competitiveness' thing mentioned above, the Sch 19 stuff is now abolished. The regular stamp duty on buying the UK equities is still with us.

In theory if every new joiner's £100 contribution to a fund caused the fund to buy £100 of new UK shares, it would be fair to charge 0.5% to that person. In reality, if part of his £100 includes the stamp duty money then he is buying less than £100 of shares so the stamp will be a bit lower than 50p. And if as many people were redeeming out as were subscribing, there wouldn't be a need to buy any more underlying shares at all, and there'd be no stamp for the fund to pay, so all this entry fee paid from the new investor would just go into the fund's coffers as free money that boosted everyone's returns.

When the Sch 19 stuff was abolished earlier this year, Vanguard who had been charging 0.5% to all new joiners, looked at their investor profile and reckoned that subscriptions were outpacing redemptions by 4 to 1. This meant that they were making new purchases and incurring stamp duty on about 4/5ths of the new money subscribed. So they dropped the joining fee by a bit to take it down to 0.4% instead of 0.5%. This will go towards stamp duty and other costs of admitting new investors and so if they charge it and someone else doesn't, then the other fund will have a worse tracking error against the underlying index.

A few summary points:
* Overall the total fees of holding an index - whether by Fund or ETF - are going to be lowest if the vehicle isn't growing in size and paying stamp duties, although the largest ones are likely to be the most efficient because the costs of running it are split more ways, until you get to the point where it is so big that it becomes difficult for new capital to be deployed efficiently into underlying companies (relevant for smaller companies funds and emerging markets).

* ETFs which are a simple transparent basket, can have very low TERs. If the vehicle is a Fund, the cost of administering investor's accounts are typically higher than an ETF, though you do get FSCS protection with a regulated UK Fund which may be of value to some.

* If the above sounds like an ETF is a cheap and easy solution for passive investors, it's not necessarily true at the smaller end of the scale - because with an ETF you have to buy on a market and pay transaction fees to a broker which might be very inefficient if you want to buy about £100 a month on a day of your choosing. So they are usually more suited to larger investors - though the caveat to that is all brokers and platforms have their own fee structure which might favour one type of vehicle over another.

Does that cover it ?

isan00b90

bowlhead99 wrote: »

I think that's a red herring because HSBC's global investment centre also has a platform fee - 0.39%? You can find platforms cheaper than that to hold either HSBC or Vanguard. With Vanguard when you get to £100k you can go direct to them and skip the platform - though I appreciate that's some way off ...

Ah really? So to hold an HSBC All-Share FTSE tracker through HSBC themselves costs 0.39%?

Last time I did it I actually went into a branch, filled out a form and sent it off detailing how much I wanted to invest each month. I didn't hear or read anything about them charging 0.39%?

So what you're saying is, the best way to buy that HSBC fund would be to find a cheap fund supermarket that would charge say 0.15% or something to hold the same fund?

bowlhead99

A few years back it was typical for "retail" investors (i.e. people like you and me who don't have millions to invest like the big institutions) to only be offered funds that had relatively high management fees and paid a kickback to whichever platform you used. So you just paid an annual management fee / TER figure which was higher than it is today. You were still indirectly paying whoever ran the platform, and if it was someone affiliated with the fund manager you'd never really know how the annual fees were split out.

Now it is explicit pricing, with the annual management fee being charged in a clean way with a separate fee by the person who provides you with access via their platform and administers your account, which they won't do for free.

You are right, you can get cheaper than HSBC's 0.39% platform fee. TD Direct is 0.3. Charles Stanley Direct is 0.25. Youinvest is 0.2, but you'd need to pay £1.50 for each of your regular monthly purchases. Not sure anyone's doing as low as 0.15 on a mainstream retail platform without transaction fees, if you don't have a much bigger pot than the numbers you were talking about.

But yes basically decide what fund you want and then try to find the cheapest platform to hold it. If you were using Charles Stanley you could get Fidelity's Uk index for 0.09 on top of the 0.25 platform fee, for 0.34 total. Whether it perfoms better overall than HSBC or is not very clear because they've not been offering that cheap fund for very long. And the performance against vanguard probably depends how long you hold it, given Vanguard has the different structure with an initial charge.

Once you start shopping around for cheap options and see what a good variety of funds are available on the big cheap platforms, you might well come to the conclusion that putting all of your spare £200pm in a UK tracker is quite a high risk investment strategy (as it is a very specialist fund - most people would start with an investment fund that covers more of the world's economy, more industry sectors and maybe more asset classes than just shares). That would be a conversation for another thread!

If you stick with a UK tracker, good luck.

kidmugsy

Consider this, especially comment 17 and after.
https://forums.moneysavingexpert.com/discussion/5037990

Ryan_Futuristics

Another thing to consider is that at most points in recent history, an All Share fund would have significantly under-performed an equal weighted fund

An All Share fund is market weighted (so it's predominantly a FTSE 100 tracker) - but if you instead had your money going three ways equally (into Large Cap, Mid-Cap and Small-Cap) you'd tend to benefit much more from strong growth periods

Then that adds another dimension: value investing ... At the moment, Small and Mid-cap look over-valued (following strong recent runs) - so it may make more sense to invest in a FTSE 100 tracker now, then start putting money into a FTSE 250 when it looks better value

You could then use rebalancing and (if you wanted to get technical) a value-based asset allocation strategy to smooth out volatility and benefit from whatever state the market's in (or pick a good active fund to do this for you ... I like Neil Woodford's fund at the moment - it also gives you about some strategic exposure to foreign markets, so it's less specialised)

Passive investing has become very popular in recent years, but it doesn't change the fact that value is the only real dictator of future returns (Warren Buffett - who's helped popularised passive investing - is himself a devout value investor, but says himself that he advocates passive investing partly because no one listens to him about value)

BillJones

Ryan_Futuristics wrote: »

Another thing to consider is that at most points in recent history, an All Share fund would have significantly under-performed an equal weighted fund

Well yes, of course, as it is more heavily weighted towards higher risk stocks. On a risk-adjusted basis, the benefit disappears, as you'd expect.

Advising people to take more risks, despite not knowing their risk appetite, is not really very good advice.

Ryan_Futuristics

BillJones wrote: »

Well yes, of course, as it is more heavily weighted towards higher risk stocks. On a risk-adjusted basis, the benefit disappears, as you'd expect.
Advising people to take more risks, despite not knowing their risk appetite, is not really very good advice.

Absolutely - however if you take a value approach (using CAPE ratios, Market/GDP, Gordon Growth, etc. or find a good fund manager), and only buy markets that are trading under their value, you take the biggest risk factor out: buying overpriced stock

I'd consider buying an All Share tracker (and especially Vanguard Life Saver) marginally riskier than a FTSE 100 or UK Income tracker right now because you'd be purchasing more companies that are trading above their value, and reversion to mean is the part of the stock market you can generally predict