ETF Portfolio with European ETFs

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ETF Portfolio with European ETFs

In 2020, Swiss investors may lose access to U.S. funds. DEGIRO already cut access to these funds. And it is highly likely that Interactive Brokers does the same next year. So, we need to be prepared for that eventuality. The alternative to U.S. Exchange Traded Funds (ETFs) is European ETFs.

You can also use mutual funds. It is almost the same thing. However, it is much more flexible to invest through ETFs in Europe. The main problem is that European ETFs are inferior to U.S. ETFs in many ways, as we are going to see in detail. Unfortunately, we may not have the choice to use them. The alternative of not investing at all would be much worse!

In this post, we are going to go through the multiple steps of designing a new portfolio. First, you need to decide the allocation of the different parts of the portfolio. Then, you need to choose between different stock market indices. Finally, you need to select the best ETF for each index. I believe it is an excellent exercise. However, it is not trivial and should not be taken lightly.

European ETFs

European ETFs have almost only disadvantages compared to U.S. ETFs.

First of all, they often have higher fees. The TER of European funds is almost always higher than the TER of U.S. funds. It is quite sad. For instance, Vanguard total world fund (VT) in the U.S. has a TER of 0.09%. Their European equivalent Vanguard FTSE All-World ETF has a TER of 0.25%. This TER is almost three times more expensive. In some cases, you will find European ETFs with reasonable fees. But this will not be possible most of the time.

Not only are their fees higher, but trading European ETFs is more costly than trading U.S. ETFs. On all the brokers I know, trading European ETFs is more expensive than trading U.S. ETF. On Interactive Brokers, I can trade a U.S. ETF for less than 50 cents. But it cost me at least five times more to trade a Swiss ETF. That is pretty bad!

Another problem with European ETFs is that they are much smaller than their U.S. equivalent. A smaller fund means a larger bid/ask spread. It also means lower liquidity due to the lower trading volume. There is also a small risk that a fund that is too small gets closed. And finally, a fund that is too small cannot replicate the index as well as a bigger fund.

One big problem that many people do not consider is the difference in dividend taxes for many European investors. I did not research all the European countries. But this is true for Swiss investors. You should check if the same applies to you in your country. If you invest in U.S. funds, 30% of the dividends will be taxed.

However, you can reclaim 15% of the taxes via a W8BEN-E form. And some brokers, such as Interactive Brokers, will do that for you directly. And you can also account for the remaining 15% in your tax declaration. If you use Swiss funds, you will be taxed at 35% of the dividends. And there will not be a way to get it back! It is more important than the TER of the fund!

If you have access to only European ETFs, the best is actually to use bunds based in Ireland. In that case, you will be able to reclaim 15% of the dividends. But you will not be able to reclaim the 15% withheld by the U.S. taxes.

My current ETF Portfolio

For a reference, let’s take the ETF Portfolio I am currently recommending:

  • 20% Swiss Stocks: iShares Core SPI ETF (CHSPI): A TER of 0.10%.
  • 10% U.S. Stocks: Vanguard S&P 500 ETF (VOO): A TER of 0.04%. This fund has about 103 billion CHF.
  • 70% World Stocks: Vanguard Total World ETF (VT): A TER of 0.09%. This fund has about 12.71 billion CHF of Assets Under Management (AUM).

The average TER of my portfolio is 0.087%. It may not be perfect, but I like this portfolio. I am only considering changing the allocation to U.S. Stocks.

If I did not have access to U.S. funds, I would need to find two new funds for my U.S. stocks and the World Stocks. For this exercise, we are going to keep the same portfolio. There is no need to choose different stock market indexes. However, for each index, we need to choose a fund that follows it.

S&P 500 ETF

Let’s start by replacing the S&P 500 ETF. There are quite a few options available to us (you can search on justETF, for instance). There are three options that I would consider for this ETF:

  • Invesco S&P 500 UCITS ETF: A TER of 0.05% and AUM of 4.5B
  • iShares Core S&P 500 UCITS ETF: A TER of 0.07% and AUM of 8B.
  • Vanguard S&P 500 UCITS ETF: A TER of 0.07% and AUM of 22B.

Given these choices, I would personally take the Vanguard fund. It has a slightly higher TER than Invesco. But it is five times bigger. And I like Vanguard Philosophy.

European ETF Portfolio with Total World ETF

For the world ETF, there are two indices that we can consider: The MSCI World index and the FTSE All-World index. Here are some interesting ETFs following these two indexes:

  • HSBC MSCI World UCITS ETF: A TER of 0.15% and 1.6B of assets.
  • Invesco MSCI World UCITS ETF: A TER of 0.19% and 711M of assets.
  • Vanguard FTSE All-World UCITS ETF: A TER of 0.22% and AUM of 3.5B.
  • iShares MSCI World UCITS ETF (Dist): A TER of 0.50% and 5B of assets.

Honestly, I do not like any of these options. The first two funds are simply too small, and the last two are too expensive. European options for World ETF are pretty weak. But that is the way it is. If I had to choose, I would take the HSBC fund.

I try to only invest in distributing funds. It has several advantages when you are retiring.

However, if you are considering investing in accumulating funds as well, you can consider the iShares MSCI World UCITS ETF (Acc). It has a TER of 0.20% and considerable AUM of 17B dollars. This iShares ETF is a good fund if you want to invest in accumulating funds. It is still more expensive than the HSBC fund. But it is much larger.

That would give an updated portfolio with 0.129% TER. The difference is not so bad, but it is still a significant increase of about 30% of fees. And the quality of the ETFs is quite inferior.

Breaking down the world ETF

Can we break down the World ETF?
Can we break down the World ETF?

Since the European ETFs are not good, we can try to replicate the performance of the World index by using several ETFs. Here is the composition of the Vanguard World ETF (VT):

  1. North America: 58.40%
  2. Europe: 18.60%
  3. Pacific: 13.30%
  4. Emerging Markets: 9.40%
  5. Middle East: 0.20%
  6. Other: 0.10%

I think we can safely ignore the last two regions and still have a good representation of the entire market. If I were to replicate the performance of the world ETF, I would use the following percentages:

  1. United States: 60%
  2. Europe: 15%
  3. Pacific: 15%
  4. Emerging Markets: 10%

But the World ETF is only 70% of my portfolio. If we take this into account, I think I would go with:

  • Swiss Stocks: 20%
  • U.S. Stocks: 50%
  • Pacific Stocks: 10%
  • Europe Stocks: 10%
  • Emerging Markets Stocks: 10%

You could also go 5% of Emerging Markets or even nothing. But that would probably be too much optimization already.

Now that we have our new allocation, we need to find ETFs for these regions. We already have an ETF for the first two regions. We need one for the three remaining regions: Pacific, Europe, and Emerging Markets.

Pacific ETF

Let’s start with stocks from the Pacific region. A few indices are covering the Pacific. What is interesting is that Japan is out of these indices. Since the big collapse of the Japanese market around 1986, it has been excluded from many indices. I can live without the Japanese stock market in my portfolio. If you cannot, you can simply use a Japan index as well as a Pacific index. Therefore, we can go with the MSCI Pacific ex-Japan index. There are a few ETFs option for this index:

  • iShares Core MSCI Pacific ex-Japan UCITS ETF (Acc): A TER of 0.20% and 1.6B of managed assets.
  • UBS ETF (LU) MSCI Pacific (ex-Japan) UCITS ETF (USD) A-dis: A TER of 0.30% and 175 million CHF managed.
  • HSBC MSCI Pacific ex Japan UCITS ETF USD: A TER of 0.40% and 36 million of AUM.

Once again, this is not great. Usually, I would take a fund that distributed dividends instead of accumulating. But here, I would not pay the premium. Moreover, the last two funds are simply too small. And the last one is too expensive. So, I would personally go with the iShares fund for my 10% Pacific stocks.

Europe ETF

We need a Europe ETF
We need a Europe ETF

Now, we need an ETF for the European region. Quite a few indices are covering this region. The first index we can take a look at is the FTSE Developed Europe index. Another one is the MSCI Europe index. Both these indexes only cover large-cap and mid-cap companies. A very popular index is the STOXX Europe 600 (or Euro Stoxx 600). It is a bit special since it contains 200 large-cap companies, 200 mid-cap companies, and 200 small-cap companies. I think it is an interesting index as well.

There are other indexes, for instance, the MSCI EMU. But in my opinion, these are the best representatives of the performance of the European companies. So, let’s see the best ETFs we can find with these indexes:

  • iShares Core MSCI Europe UCITS ETF: 5.1B of AUM and a TER of 0.12%.
  • Vanguard FTSE Developed Europe UCITS ETF: 1.8B of AUM and a TER of 0.12%
  • Xtrackers MSCI EMU Index UCITS ETF 1D: 2.4B of AUM and a TER of 0.12%.
  • Amundi STOXX Europe 600 UCITS ETF: 435M of AUM and a TER of 0.18%.
  • Invesco MSCI Europe UCITS ETF: 529M of assets and a TER of 0.19%
  • Invesco STOXX Europe 600 UCITS ETF: 279M of assets and a TER of 0.19%.

Given these choices, I would go with the iShares Core ETF. It is large enough, and the TER is quite good. Moreover, I prefer the MSCI Europe index to the FTSE Developed Europe index. But again, these are personal reasons. You can choose another ETF or another index!

Emerging Markets ETF

The last ETF we have to choose is an ETF for the Emerging Markets. There are two leading indices for these markets: The MSCI Emerging Markets and the FTSE Emerging Markets. I do not have a preference for one or the other. Let’s look at the best ETFs for these two indices:

  • iShares MSCI Emerging Markets UCITS ETF (Dist): 2.3B CHF of AUM and a TER of 0.18%
  • Amundi MSCI Emerging Markets UCITS ETF (Acc): 3.8B CHF of AUM and a TER of 0.20%.
  • Xtrackers MSCI Emerging Markets UCITS ETF 1C (Acc): 1B of assets and a TER of 0.20%.
  • UBS ETF (LU) MSCI Emerging Markets UCITS ETF (Dist): 1.3B and a TER of 0.23%.
  • Vanguard FTSE Emerging Markets UCITS ETF (Dist): 1.8B CHF of AUM and a TER of 0.25%.
  • HSBC MSCI Emerging Markets UCITS ETF USD: 2.5B CHF of assets and a TER of 0.40%.

In this case, I would go with the iShares MSCI Emerging Markets UCITS ETF. It is a distributing ETF, with a large size and a low TER.

European ETF Portfolio with multiple ETFs

Finally, we are done! We have chosen a portfolio, chosen the stock market indices, and chosen the ETFs. Here is the portfolio finally:

  • Swiss Stocks: 20%: iShares Core SPI ETF (CHSPI): TER of 0.10%.
  • U.S. Stocks: 50%: Vanguard S&P 500 UCITS ETF: TER of 0.07%.
  • Pacific Stocks: 10%: iShares Core MSCI Pacific ex-Japan UCITS ETF (Acc): TER of 0.20%.
  • Europe Stocks: 10%: iShares Core MSCI Europe UCITS ETF: TER of 0.12%.
  • Emerging Markets Stocks: 10%: iShares Emerging Markets UCITS ETF (Dist): TER of 0.18%.

This portfolio gives us a global TER of 0.105% for the entire portfolio. This portfolio is only slightly better than the version with the world ETF. It only has 0.024% fewer fees. And instead of merely having three funds, you have five funds.

I do not think this is better, honestly. But if you want to minimize fees, this is the way to go. And I believe that these funds are a bit better together than the HSBC world fund. But it is up to you to decide if you prefer lower fees or a simpler portfolio.

Conclusion

As you can see, it is not an easy thing to design an entire ETF portfolio from scratch. First, you need to decide the allocation of the different regions or even investing instruments (bonds and stocks, for instance). Then, for each of these assets, you need to find the stock market index that you want to invest in. Finally, you will need to find the best ETF for each index.

In the end, we end up with a portfolio with inferior funds with about a 30% increase in fees. And this is not counting the significantly higher trading fees. Finally, we are going to pay much more taxes on the dividends since we cannot reclaim the U.S. dividends anymore. Overall, we are probably looking at twice the fees of the original portfolio.

Unfortunately, we may not have the choice to do the switch. If Interactive Brokers applies the new laws to Swiss investors, we will be stuck with European ETFs. Therefore, it is still better to be prepared for this eventuality.

How would your portfolio look like without U.S. funds? Would you do it differently?

Mr. The Poor Swiss

Mr. The Poor Swiss is the author behind thepoorswiss.com. In 2017, he realized that he was falling into the trap of lifestyle inflation. He decided to cut on his expenses and increase his income. This blog is relating his story and findings. In 2019, he is saving more than 50% of his income. He made it a goal to reach Financial Independence. You can send Mr. The Poor Swiss a message here.