ETF v's OEIC Questions

[Helinlouise]

Hi,

Newby to the forum and have been lurking for sometime to gather information. Now for my first post!

I am looking to invest some monies and have set about reading various websites and the excellent Tim Hale book. However, there is something that is just not clicking in my brain - ETF's v's OEIC's.

I have read this board, specifically thread 'Future of OEIC vs ETFs' (sorry the site wont let me post the link) and understand and comprehend the following:

ETF's are traded in real time, OEIC's have a price once a day
ETF's are not applicable for FSCS compensation
OEIC are actively managed, ETF track an index and therefore passive
OEIC can be charged more platform fees, but if the platform is charging a flat fee e.g. Iweb, then this is not an issue
ETF's and OEIC's tracking the same index have no discernible difference in the long term total return (as per above thread)

I would (until I understand more), be investing in UK domiciled funds only and I fully understand the need to check what indices the fund tracks and its constituent components.

My gut reaction is to invest in OEIC's but I think this is because they are within the FSCS compensation scheme and the product feels in my comfort zone. However, my nature is to understand what I do not understand before I decide what to do.

My strategy is to buy and passively invest i.e. I will not be trading very much at all.

If I stick to OEIC's and understand the above points, am I missing a huge point in relation to ETF's and what is it?

I am an additional rate tax payer in the UK if that makes any difference (I have not yet researched the tax consequences of either).

Thanks in advance for any answers.

Helen

[GeoffF100]

OEICs are not all actively managed. The index trackers are not.

UK domiciled OEICs are eligible for FSCS compensation. Those domiciled in Ireland are not. A majority of the Vanguard OEICs are now domiciled in Ireland and have more complicated tax reporting. There is almost no chance of an index tracking OEIC from one of the big providers going bust.

Tax reporting is easier for UK domiciled OEICs, but that does not necessarily mean you pay less tax. It is usually best to use the distributing versions of either type of fund outside a tax shelter. ETFs often pay their dividends in dollars, and many brokers (not iWeb) charge foreign exchange commission to convert them into pounds.

Most platforms charge more to host ETFs than OEICs. iWeb and Interactive Investor do not charge more, and Vanguard caps its platform fee at £375.

[JohnB]

Hargreaves Lansdown charge nothing to host ETFs, the same as they do for shares. They charge for OEICs.

ETF and OEIC are wrappers, the underlying thing might be active or passive. A higher fraction of ETFs are passive, perhaps as the setup seems cheaper to run.

[Alaric]

I am an additional rate tax payer in the UK if that makes any difference (I have not yet researched the tax consequences of either).

If you hold ETFs outside of tax shelters, ISAs and SIPPs, reporting on income for tax purposes can be a pain. That's because what has to be reported is a bit obscure because being based in Dublin and other non-UK locations they fall into the regime for taxing offshore funds. To compound matters whilst UK Brokers are compelled to report taxable income on OEICs to the holder, no similar requirement exists for ETFs.

[mc2fool]

Most platforms charge more to host ETFs than OEICs.

Other way round.

[tjh290633]

You might like to consider investment trusts as well as ETFs and OEICs. In my view the big global ITs offer better prospects than any trackers.

TJH

[GeoffF100]

Most platforms charge more to host ETFs than OEICs.

Other way round.

Quite so. I bashed that post out quickly, but I think it covers the main points. OEICs are the simplest option for the OP. The only risk is that there are only a few platforms that do not charge swinging percentage fees for holding them. Provided that they are Vanguard funds, there is the backstop of Vanguard's own platform, but that still is not particularly cheap.

[GeoffF100]

You might like to consider investment trusts as well as ETFs and OEICs. In my view the big global ITs offer better prospects than any trackers.

ITs are managed funds and much more expensive than trackers. They are fair enough if you want a punt, but they could under perform the global index badly.

[tjh290633]

You might like to consider investment trusts as well as ETFs and OEICs. In my view the big global ITs offer better prospects than any trackers.

ITs are managed funds and much more expensive than trackers. They are fair enough if you want a punt, but they could under perform the global index badly.

They could but they don't.

TJH

[xxd09]

OEICs and ETFs are essentially the same product but with some individual foibles of their own
You won’t fail using either product as they essentially do the same job
OEICS are funds that are reconciled price wise once a day
ETFS trade all the time like a share
Some investment platforms discriminate between the two products price wise -this could affect your choice
There might be some slight differences in running costs
As an older investor who used OEICs because ETFs were not available I have felt no need to change
Starting out now I would probably have used ETFs
As a historical note ETFs were created to allow constant trading(like a share) but really the point of index investing is to buy and hold and not trade so ETFs not really necessary except for active investors
xxd09

[GeoffF100]

ITs are managed funds and much more expensive than trackers. They are fair enough if you want a punt, but they could under perform the global index badly.

They could but they don't.

I think you are confusing the past tense with the future tense. We do not know what will happen in the future. We do, however, know that a global tracker is the most diversified equity portfolio, and that ITs have less diversified portfolios, which increases risk. Some of them also have borrowing, which also increases risk. They also have higher costs and charges. Nonetheless, if you feel in your waters that a particular IT will do well, you are free to buy it.

[londoninvestor]

As a historical note ETFs were created to allow constant trading(like a share) but really the point of index investing is to buy and hold and not trade so ETFs not really necessary except for active investors

Also, for US investors, an extra motivation is that ETFs have tax advantages over mutual funds (roughly the US equivalent of OEICs).

That's not really a factor in the UK - as said above, the tax information is a bit easier to get at for onshore OEICs compared to offshore ETFs, but the actual tax payable is basically the same.

[Lootman]

As a historical note ETFs were created to allow constant trading(like a share) but really the point of index investing is to buy and hold and not trade so ETFs not really necessary except for active investors

I would argue there is a bit more to using ETFs than just being able to day trade them which, I agree, rather misses the point of indexing.

For a start you know the exact price you are buying or selling at, rather than having to wait until the end of the trading day to know.

Also structuring the fund as a tradeable security allows for lending, shorting and hedging, which are hard or impossible to do via open-ended funds. And at least in the US a wide range of ETFs have listed options on them, which allows for a wider range of strategies such as selling calls, downside protection and stock replacement.

They could but they don't.

I think you are confusing the past tense with the future tense. We do not know what will happen in the future. We do, however, know that a global tracker is the most diversified equity portfolio, and that ITs have less diversified portfolios, which increases risk. Some of them also have borrowing, which also increases risk. They also have higher costs and charges. Nonetheless, if you feel in your waters that a particular IT will do well, you are free to buy it.

Surely the main distinction is that ITs are active and ETFs are (mostly) passive.

I would argue that a much more important distinction is which market you seek to invest in. So for example over the last 25 years the UK market has barely moved but the US market has quadrupled. And the USD has been stronger.

So getting your high level allocation decision right, US versus UK in this case, was a lot more important than getting your ETF versus IT versus OEIC decision right.

[tjh290633]

They could but they don't.

I think you are confusing the past tense with the future tense. We do not know what will happen in the future. We do, however, know that a global tracker is the most diversified equity portfolio, and that ITs have less diversified portfolios, which increases risk. Some of them also have borrowing, which also increases risk. They also have higher costs and charges. Nonetheless, if you feel in your waters that a particular IT will do well, you are free to buy it.

No, I am not. They have at least kept pace with their appropriate indices and there is no reason why they should not continue to do so. They have a lot longer track record than either ETFs or tracker funds and being able to buy at a discount more than compensates for slightly higher charges. Being invested in everything means that you have the bad as well as the good. A little discrimination can be a good thing.

TJH

[GeoffF100]

[Being invested in everything means that you have the bad as well as the good. A little discrimination can be a good thing.

Only if you have a better than chance rate of success at stock picking. The evidence shows that, in the long run, trackers beat nearly all managed funds. Nobody, has come up with a way of identifying which funds will outperform in advance with abetter than chance rate of success.

[Helinlouise]

Thank you to all who replied, this has really helped me understand.

I will have a substantial amount of money outside of tax wrappers as I have used ISA allowances and don't have a SIPP (I have maxed out contributions under my work pension), so I will most probably do a mix of both ETF's and OEIC's across platforms but will keep it UK domiciled until I am more comfortable with the forex and tax reporting.

Thanks again, this forum has been an invaluable resource to me.

[xxd09]

It might be easier tax wise if you have substantial funds ( out with tax free wrappers ie SIPPs and ISAs) but generating dividends/income to have those funds set up in income rather than accumulation mode
This makes tracking of income produced by the funds easier for you-important when assessing yourself for tax with the HMRC
xxd09

[londoninvestor]

I will most probably do a mix of both ETF's and OEIC's across platforms but will keep it UK domiciled until I am more comfortable with the forex and tax reporting.

Be aware that there are no UK-domiciled ETFs. The ones commonly used by UK investors are mostly domiciled in Ireland. That does make the tax reporting a bit more of a hassle, like you say.

Forex issues aren't tied to domicile per se (an Ireland-domiciled fund doesn't necessarily operate in euros, for example). You can use sterling to buy and sell many ETFs, but (unless the ETF invests in mostly UK assets), the dividend is likely to be paid in another currency, often USD.

Potential mitigations to this are:
1) Make sure you hold the ETF on a platform that doesn't charge for FX conversion of dividends. For example, iWeb doesn't charge, as discussed here: viewtopic.php?p=661564#p661564

2) Use a fund with an "accumulation" share class so that the dividends are not paid out as cash, but rolled up into the value of the share. The dividends are still taxable as dividend income though, which as mentioned adds a bit of admin.

[GeoffF100]

2) Use a fund with an "accumulation" share class so that the dividends are not paid out as cash, but rolled up into the value of the share. The dividends are still taxable as dividend income though, which as mentioned adds a bit of admin.

There is a nasty catch with that when the fund already has a large capital gain. When a dividend is paid and reinvested within an accumulating fund, the dividend is pooled with the rest of the fund for Capital Gains Tax (CGT) purposes. If you then sell units in the fund the recover the dividend, you not only pay tax on the dividend but also pay CGT tax on the capital gain.

[londoninvestor]

2) Use a fund with an "accumulation" share class so that the dividends are not paid out as cash, but rolled up into the value of the share. The dividends are still taxable as dividend income though, which as mentioned adds a bit of admin.

There is a nasty catch with that when the fund already has a large capital gain. When a dividend is paid and reinvested within an accumulating fund, the dividend is pooled with the rest of the fund for Capital Gains Tax (CGT) purposes. If you then sell units in the fund the recover the dividend, you not only pay tax on the dividend but also pay CGT tax on the capital gain.

Indeed, as we were discussing on the linked thread Something to think about if the goal is to use income from the investment to fund spending.