This edition of Peter’s Perspective was authored by Churchouse Publishing analyst Tama Churchouse
In the last edition of Peter’s Perspective, Outperformance & Lower Risk, I wrote about how making some minor tweaks to how you buy U.S. equities could let you both outperform the benchmark AND do so with less volatility.
We had quite a few responses from our readers… one wrote in;
(And we HATE fees)
As our reader points out above, common sense usually means less complication… And banks LIKE complication. They LIKE the bells and whistles. More complication = more fees. It’s that simple.
With that in mind, today I’m bringing you another super simple idea.
Firstly I should clarify, if you’re a U.S. citizen, then this won’t help you much.
But for everyone else, the financial benefits of implementing what I’m about to talk about are potentially highly significant for your investment income.
So here’s a question for you:
Let me explain.
The explosive growth of ETFs over the past decade has been well documented. At Churchouse Publishing, we’re a big fan of ETFs.
Around 25% of all ETFs are listed in the U.S. There’s plenty of liquidity. The U.S. market is easily accessible by most global investors. There’s a huge range of ETF asset classes and styles to choose from.
And ultimately, the U.S. is typically the first port of call when investors look for ETFs.
So let’s say I want to invest in Global Emerging Market Bonds….
I do a quick search and I see that the largest ETF in this space is the iShares JPMorgan USD Emerging Markets Bond Fund (EMB US).
It has about US$4.4bn in assets under management (AUM). It tracks the JPMorgan Emerging Markets Bond Index (JPEICORE) which is the global benchmark of Emerging Market US$-denominated government debt.
The expense ratio is 0.60%, and the trailing 12 month yield* is 4.44%. It pays out distributions to shareholders every month.
*This is the sum of all the previous 12 monthly distributions divided by the most recent NAV (Net Asset Value)
Unfortunately there’s a problem.
If you’re a non-U.S. citizen, you won’t have received that 4.44% yield.
As an offshore investor you are liable to pay up to 30% withholding tax to the U.S. government on your income.
This amount can be reduced if your country has a tax treaty with the U.S. and you file a W-8BEN form to the U.S. tax authorities. But it varies from country to country. Most Asian countries DO NOT have a dividend tax treaty with the U.S.
For example, many of our readers live in Hong Kong which has no tax treaty with the U.S.
That means you don’t get 4.44%…. you only 3.11% after withholding tax…
You are paying a full 1.3% of your 4.44% annual income to the U.S. government!!!
Let’s put some more number on this. Say you bought US$100,000 worth of this ETF five years ago.
Without any withholding tax, you would have received US$25,635 over 60 monthly distributions.
After withholding tax, your 60 months of distributions would equal roughly US$17,944.
But you don’t live in the U.S.
The underlying bonds have absolutely nothing to do with the U.S. (i.e. the income is all generated outside of the U.S. )….
…..but over five years you’ve paid nearly US$8,000 to American taxman!
I wish I could find a more eloquent way of saying this but…. that completely SUCKS.
What else can we do? The average investor can’t just go out and buy all these bonds themselves….
But what if I offered you an alternative ETF?
- It’s managed by the exact same provider (iShares).
- It tracks the exact same underlying index (the JPMorgan Emerging Markets Bond Index Global Core Index).
- It’s also US$ denominated.
- It’s almost the same size in terms of AUM (US$3.88bn vs. US$4.44bn).
- It’s 25% CHEAPER with an expense ratio of just 0.45% (instead of 0.60%).
- It has a trailing yield of 4.54%.
- And, combined with no withholding tax means that over 5 years you would have received FIFTY PERCENT MORE INCOME.
Did you know this was possible? If not, maybe because nobody’s told you yet!
Your financial advisor is probably too busy trying to sell you high-fee structured products and actively managed funds that underperform their benchmarks.
Your retail bank couldn’t care less. If anything they’re looking to sell you their own high expense mutual fund type investments or yet more structured products.
Your broker? As long as you keep churning trades then they’re happy.
Your Private Banker? Well after nearly a decade working in investments banks and in particular with Private Banks, let me tell you Private Banks are not interested in offering you simple low-cost investment solutions! (Anyone who disagrees with this feel free to let me know).
But I digress…
How do you increase your income by 50%?
You go to London…
Not in person (unless you like terrible weather)… but the alternative ETF I’m talking about is the iShares J.P. Morgan $ Emerging Markets Bond UCITS ETF (IEMB LN). And it’s listed in London.
But the key here isn’t where the fund is listed; it’s where the fund is domiciled. In this case, the fund is domiciled in Ireland.
And funds domiciled in Ireland have no withholding tax applied to investor distributions.
So thanks to a little digging, we have an ETF that tracks the same underlying index, holds almost identical underlying bonds, has the same manager, carries LESS fees, and increases our income by fifty percent! Just by buying the London listed ETF!
I should point out here that I’m (clearly) not a tax specialist. I’m just an investor who has a lot of U.S.-listed ETFs in his portfolio and is fed up with paying 30% of my income to the U.S. government!
But this all adds up…. take a look at the difference in accumulated income over 5 years below…. this is HUGE for a passive fixed income ETF.
Judging by the numerous conversations I’ve had with friends and acquaintances about investing, I know that when investors look for an ETF, by default they look at U.S. listed ones.
So if you are a non-U.S. investor with any U.S. ETFs in your portfolio then you must look into ETFs that are domiciled outside the U.S. (in particular Ireland and Luxembourg).
Because, this isn’t just for fixed income, it’s for ANY ETF… The dividends in your U.S.-listed equity ETFs also get a similar treatment (worse in some cases!).
Did you know that a U.S.-listed ETF holding Asia Pacific ex Japan equities suffers from a total withholding tax of nearly 40 percent?!?
Depending on the size of your investment portfolio, making these kinds of adjustments could mean finding thousands or tens of thousands of dollars of extra cash in your statement at the end of every year.
These guys are independent financial advisors I’ve known and trusted for a long time. (And no, before you ask, we have no financial or business arrangement with EXS Capital!).
They’ve been researching this in depth as they have also been trying to work out how to ensure their clients wealth is managed as efficiently as possible. For passive ‘set it and forget it’ portfolios, this kind of strategy is simply essential.
We’ll be going deeper into this for our subscribers in The Churchouse Letter – the message here isn’t “Quick! switch all your ETFs to London-listed ones!” – there are a lot of other factors that we need to take into account but diving into them here would triple the length of this Peter’s Perspective.
But in the meantime, make sure you keep this strategy on your investment radar and share it with anyone you think would appreciate earning more cash on their ETF investments.