UK Investment Trusts vs ETFs as a Post Tax Investment Vehicle in Ireland

[Younginvestor93]

Exchange Traded Funds: In the Irish context we are going to be looking at accumulating Irish domiciled ETF's where dividends are reinvested automatically in the fund.

Pros

1. Dividends are reinvested automatically in the fund so tax is only paid on exit every 8 years or when you sell.
2. ETF's provided access to globally diversified funds and are passively managed tracking an index. Passive investors have outperformed active investors over the long run a large majority of the time.
3. You can get access to global ETFS through SPDR® MSCI World UCITS ETF | SPPW and iShares MSCI EM IMI UCITS ETF | IS3N with a total TER of 0.13% or alternatively the very simple Vanguard FTSE All-World UCITS ETF | VWCE with a TER of 0.22%. I Shares also has IWDA at TER of 0.20% but State Street looks the better option in terms of value.

Cons

1. They are taxed at 41% every 8 years (deemed disposal) or when you sell, which is higher than 33% capital gains tax.
2. Tax can be challenging for the average investor if they purchase every month, having to record each transaction to pay tax on it for 8 year from the date of purchase. This can be made easier with few purchases than every month.

Investment Trusts: UK domiciled funds. Actively managed by fund managers.

Pros

1. They are taxed at 33% and your marginal tax rate on dividends. This can be a good thing if you are at a low tax rate or not if you are a high earner.
2. Some investment trusts have vastly outperformed their indexes by a large amount, although with some higher risk as some of these are highly focused on specific sectors (Bailey US Growth Trust, Scottish Mortgage Trust) and are not as well diversified as ETFs.

Cons

1. Performance is down to the investing manager so you are hoping that the fund manager will be able to outperform the index. Some have performed very poorly over 5-10 years such as Witan Investment Trust and Henderson International Income Trust.
2. Some of the fees can be high, a lot higher than what you can get with globally diversified ETF's. Some have reasonably low fees however, so you have to be careful to search out for those.
3. NAV: You can purchase the Investment Trusts at discount to the Net Asset Value or more than Nav at other times. I am not an expert on this and perhaps others in this forum have a better understanding but this adds complexity as to whether to both accumulating stages and on sale of the funds.
4. It is harder to find appropriate IT's that can give you a globally diversified portfolio in comparison to ETF's which are more straightforward.
5. Currency Fluctuation: Again I am not well versed in this area but my understanding is that a drastic change in currency could result in you losing a significant amount of your funds when you are looking to withdraw. Perhaps other posters could shed more light on the currency risks.
6. Should an investment trust go bankrupt. Are the assets safe? I could be wrong but I don't think the safety of your investment is as secure in an investment trust as it would be in an ETF. Mrsmoneyhacker(article linked below) suggests not having more than 5% of your overall assets invested in one single company.

Paddy Delaney has an interesting blog on investment trusts looking at the pros and cons of investment trusts: https://www.informeddecisions.ie/investment-trusts-in-ireland-blog-159/

Mrs.Money Hacker also weighs up the pros and cons of IT's here: https://mrsmoneyhacker.com/how-investment-trusts-compare-to-etfs/

They both suggest that it may not be such a simple case of IT's have no deemed disposal and 33% tax so they are clearly better. There are a few more complex factors to account for when investing in IT's but some IT's have the potential to outperform ETF's if you pick the right ones!

Anyone have any thoughts on the IT vs ETF discussion or can shed more light of some of the points above?

Do you invest in ETF's or IT's outside of your pension and if so which ones and why?

Does anyone know what happens to an individuals assets upon death, if they hold an ETF vs if they hold an Investment Trust, how does the capital gains tax/inheritance tax play out?

 

[RedOnion]

I'm going to attempt to comment on some of your questions, based on my own observations as a lay person. I think we've addressed some of them in multiple threads, so it's good to see them all in one place.

Firstly, it's important to note that there is not one 'correct' answer for everybody. If there was, then there would only be one investment option.

Disclosure: I don't personally currently hold any Investment Trusts. But I hold equities outside a pension wrapper. This is for reasons specific to my circumstances: in part because I have material capital losses carried forward, and I want any investment gains I make to be subject to CGT.

1. ETF's provided access to globally diversified funds and are passively managed tracking an index. Passive investors have outperformed active investors over the long run a large majority of the time.
2. You can get access to global ETFS through SPDR® MSCI World UCITS ETF | SPPW and iShares MSCI EM IMI UCITS ETF | IS3N with a total TER of 0.13% or alternatively the very simple Vanguard FTSE All-World UCITS ETF | VWCE with a TER of 0.22%. I Shares also has IWDA at TER of 0.20% but State Street looks the better option in terms of value.

Not all ETF's are created equally, and you've picked some interesting examples. There are different ways that an ETF can 'replicate' the index it's tracking. 'Full physical replication' means the ETF is buying shares in the same proportions as the index, so there should be a low tracking error vs the Index.
Not all ETFs do this.
Some of the ones you've listed have tracking errors up to 2% in a year. This may be because they use 'optimised sampling' to replicate the index; that is, the investment managers are choosing the sample of the index that they think will lead to the same results. But it's a sample. Much the same way as some Investment Trusts operate.
There are other methods, including synthetic, where they don't actually buy the underlying shares at all, but use derivatives. Again the tracking error is important, but also counterparty risk.

They are taxed at 41% every 8 years (deemed disposal) or when you sell, which is higher than 33% capital gains tax.

Some additional cons:
1. Purchasing an ETF makes you a 'chargeable person', and have to submit a Form 11 tax return.
2. Losses cannot be offset against gains in different ETFs.

They are taxed at 33% and your marginal tax rate on dividends. This can be a good thing if you are at a low tax rate or not if you are a high earner.

1. CGT can be very beneficial. For example, I have large capital losses carried forward. So for the tax treatment is not 33% vs 41%, but rather 0% vs 41%. We'll mention death later.
2. CGT gains & losses can be offset
3. Re dividends: This depends on the level of dividend payout in addition to your marginal tax rate. Some IT's specifically invest in 'dividend kings' so have a high dividend payout rate. There's a market for these, for example low tax rate pensioners.

Some investment trusts have vastly outperformed their indexes by a large amount

You need to understand what the investment aims of the specific investment trust actually is. Neither of the ones you've mentioned have a stated aim of tracking any particular index that I can see.

Currency Fluctuation: Again I am not well versed in this area but my understanding is that a drastic change in currency could result in you losing a significant amount of your funds when you are looking to withdraw. Perhaps other posters could shed more light on the currency risks.

This is a complete red herring. The currency fluctuation risk doesn't exist.
The only FX issue to worry about is the fees on exchanging between EUR & GBP on entry & exit.

Should an investment trust go bankrupt. Are the assets safe? I could be wrong but I don't think the safety of your investment is as secure in an investment trust as it would be in an ETF. Mrsmoneyhacker(article linked below) suggests not having more than 5% of your overall assets invested in one single company.

I don't know who Mrsmoneyhacker is, so I've no idea what credentials she has when you quote her as a source.
Have you looked at the balance sheet of any investment trust, before worrying about bankruptcy / liquidation? Particularly the liability line, as these are the creditors that would get paid out before the shareholders.
And have you looked at what happens in a liquidation even in an EFT? (There are far more EFT liquidations to look at historically than IT bankruptcies).

Paddy Delaney has an interesting blog on investment trusts looking at the pros and cons of investment trusts

Again, I don't know Paddy Delaney, but I've previously shown you how his comparison of growth is incorrect as he doesn't treat exit tax cashflows on a like-for-like basis. I haven't read the linked page in enough detail to comment on it.

Does anyone know what happens to an individuals assets upon death, if they hold an ETF vs if they hold an Investment Trust, how does the capital gains tax/inheritance tax play out?

At a really high level:
CGT: On death, all gains are exempt from CGT. However, as with all UK equities, there is a threshold (£325k) above which UK inheritance taxes could come into play.
Exit Tax: On death, the units are treated as immediately sold & repurchased, creating a chargeable event subject to tax. The tax paid is treated as a credit which can be offset against inheritance tax for beneficiaries. But, say your spouse is only beneficiary; there is no CAT due on inheritance, so the credit can't be used. Similarly if there is no inheritance tax due from any beneficiaries if below their CAT Bands.

 

[Younginvestor93]

@RedOnion
In relation to the ETFs I have mentioned. I know you said they have a tracking error of up to 2%. My understanding is that these are the best physical replicating ETFs on offer for global equities with almost no tracking errors?

I understand other ETFs may not track as well but the ones I have referred to I understand to be almost perfect and the premier ETFs available to European investors?

Also for a retured pensioner, would it be worthwhile to opt for a high dividend IT, say a City of London Trust or a low dividend IT if income is not an issue?

Can the high dividend trusts compete with some of the big growth trusts, can't somebody just take income from their trust by selling some shares when they want income instead of getting paid dividends if they want income?

 

[RedOnion]

I understand other ETFs may not track as well but the ones I have referred to I understand to be almost perfect and the premier ETFs available to European investors?

Did you look them up yourself, and compare to the benchmark index?

 

[Younginvestor93]

Did you look them up yourself, and compare to the benchmark index?

I saw VWCE is off by .02 or .01 for the last 2 years? I thought you mentioned 2% maybe that what you are referring to.

 

[RedOnion]

I saw VWCE is off by .02 or .01 for the last 2 years? I thought you mentioned 2% maybe that what you are referring to.

Sorry, error on my part.
I wasn't referring to VWCE, but I looked at the wrong thing. I was comparing to the MorningStar benchmarks for each, rather than the actual Index they're tracking. There is an error, but it's a lot smaller than I thought.

 

[Younginvestor93]

3. Re dividends: This depends on the level of dividend payout in addition to your marginal tax rate. Some IT's specifically invest in 'dividend kings' so have a high dividend payout rate. There's a market for these, for example low tax rate pensioners.

Can you elaborate on the market for the high dividend IT's please. I can't understand the benefits of them, I get that they pay income but how is that more useful than just selling your assets in any IT when you want income yourself rather than getting paid divdidends?

How can you compare the high dividend trusts with the growth trusts, because the high dividend trusts don't appear on any stats tables of successful trusts they are ranked way down. Obviously Scottish Mortgage as an example has dominated the last while, how would City of London or another high dividend trust compete with that, would it not just be better for a older retiree to just invest in a growth trust like SMT and take their own profits when they want.

The graphs of the high dividend trusts look very poor so it scares me a little. I only want to see upward graphs to confirm that stocks always go up!

 

[RedOnion]

I can't understand the benefits of them, I get that they pay income but how is that more useful than just selling your assets in any IT when you want income yourself rather than getting paid divdidends?

There are 2 aspects.

Firstly, possibly the most important, is the psychology factor. People don't like divesting their capital to live off. But they'll happily keep the same capital balance and take the dividend as income. It's purely psychological, and could lead to worse overall returns. But there are lots of people who invest in high dividend stocks for that very reason, particularly pensioners.

To compare, you'll need to get a 'total return' chart.

The 2nd is taxation. If you've got head room to earn dividends tax free, then why not?

 

[Sarenco]

I get that they pay income but how is that more useful than just selling your assets in any IT when you want income yourself rather than getting paid divdidends?

For an investor with a low marginal tax rate (for example, a retired person with a modest pension), it may be advantageous to receive a higher proportion of any return by way of dividends, as opposed to capital gains.

Bear in mind that a married couple can earn €36k per annum tax free once one spouse is over 66.

 

[Younginvestor93]

For an investor with a low marginal tax rate (for example, a retired person with a modest pension), it may be advantageous to receive a higher proportion of any return by way of dividends, as opposed to capital gains.

Bear in mind that a married couple can earn €36k per annum tax free once one spouse is over 66.

What sort of income would qualify in that case?
Would rental income count, dividends from investments, what if you were already receiving an annuity from a state pension?

 

[RedOnion]

What sort of income would qualify in that case?
Would rental income count, dividends from investments, what if you were already receiving an annuity from a state pension?

All of the above. Any income that's subject to income tax.

 

[PMU]

1. Some investment trusts have vastly outperformed their indexes by a large amount, although with some higher risk as some of these are highly focused on specific sectors (Bailey US Growth Trust, Scottish Mortgage Trust) and are not as well diversified as ETFs.

Not all ITs follow indices or benchmarks. One of the longest duration trusts simply says in it KIID: “The aim of the Company is to achieve an above average dividend yield, with long term growth in dividends and capital ahead of inflation, by investing principally in global equities.”

1. Currency Fluctuation: Again I am not well versed in this area but my understanding is that a drastic change in currency could result in you losing a significant amount of your funds when you are looking to withdraw. Perhaps other posters could shed more light on the currency risks.

This is correct, but it applies to the purchase of any non-EUR asset by someone whose functional currency is the EUR. For example, if a UK investor purchased the iShares Timber & Forestry ETF in 2007 when it traded at 12.0339 GBP, and sold it in 2016 when it traded for 15.8544 GBP. He/she made a profit of 31% before fees and taxes. Whereas an IE investor investing in the same product in EUR, purchased the ETF at a fx rate of 0.6869 in 2007, i.e. at 17.51 EUR, and sold it in 2016 when the fx rate was 0.8639, i.e. for 18.35, the IE investor just about broke even after fees etc. So currency fluctuation is risk you must take into account when investing in non-EUR assets, if the EUR is your functional currency.

1. Should an investment trust go bankrupt. Are the assets safe? I could be wrong but I don't think the safety of your investment is as secure in an investment trust as it would be in an ETF.

I'm not certain it makes a difference. If trust or an ETF goes bankrupt it's most likely because of a problem relating to the assets (e.g. inability to generate sufficient income to pay debts, poor investment decisions or asset valuations collapsing.. That is to say the assets have underperformed. You make get the liquidation value of the assets but it's unlikely to be worth much. If the assets are worth something the fund/trust would continue trading or be bought or merged with another investment vehicle

1. NAV: You can purchase the Investment Trusts at discount to the Net Asset Value or more than Nav at other times. I am not an expert on this and perhaps others in this forum have a better understanding but this adds complexity as to whether to both accumulating stages and on sale of the funds.

This is my personal view but I think the 'discount to NAV' is one of the hokiest investment metrics ever thought up. It's more a marketing tool. ITs are money management companies, not asset management companies. The NAV return is an indicator of the performance of the management team in managing the money of the trust by investing in assets to meet the trust's investment policy. The share price return tells you what the market is willing to pay for the performance of the management team. They measure two different things. If a fund is trading at a significant discount to NAV I doubt you are getting assets on the cheap, you're more likely getting a problem. A widening of the discount to NAV more likely represents consistent underperformance of the management team, rather than a bargain. And there is no guarantee it will contract. I don't think it's prudent to buy ITs on the basis of 'discount to NAV' or the longevity of the fund. A prudent investor will always carry out appropriate security analysis on the trust as you would on any similar financial company. You could supplement this by looking at research carried out on the trust by e.g. the Edison Group [broken link removed] or similar.

Also for a retured pensioner, would it be worthwhile to opt for a high dividend IT, say a City of London Trust or a low dividend IT if income is not an issue?

For a retired pensioner, if the person invests in the asset class of Foreign Income it would be prudent to consider investing in foreign income generating investment trusts that pay dividends in GBP or USD. Or the person could invest in a strategic bond fund that invests in non-EUR bonds. Basically you are diversifying sources of income, e.g. domestic income from pension and EUR-denominated investments including bonds, then foreign (i.e. not EUR) income from other sources. Bonds are probably preferable as they are a source of uncorrelated alpha, (i.e. returns that are low/uncorrelated with the returns of the other major asset classes (e.g. equities in which you are invested), but yields are currently minimal. So you could look at other sources for foreign income. [And note that bond funds are not without risk.] So a foreign (i.e. non-EUR) income IT is a possible investment vehicle. But if foreign income is not an issuet, why would you consider it?

This is a complete red herring. The currency fluctuation risk doesn't exist.
The only FX issue to worry about is the fees on exchanging between EUR & GBP on entry & exit.

This is totally incorrect. If your functional currency is the EUR, once you buy an asset in a non-EUR currency, changes in the fx rate between the EUR and the foreign currency on the date of purchase and on the date of sale will impact on your investment return expressed in EUR.

 

[RedOnion]

This is totally incorrect.

Really?

Can you please explain to me the FX risk of investing in a globally diverse range of equities via a GBP denominated vehicle Vs say a EUR one?

Or to make it easier for you to explain. Investing in a USD denominated S&P500 linked instrument Vs a EUR instrument linked to the S&P500

 

[Investor]

At a really high level:
CGT: On death, all gains are exempt from CGT. However, as with all UK equities, there is a threshold (£325k) above which UK inheritance taxes could come into play.
Exit Tax: On death, the units are treated as immediately sold & repurchased, creating a chargeable event subject to tax. The tax paid is treated as a credit which can be offset against inheritance tax for beneficiaries. But, say your spouse is only beneficiary; there is no CAT due on inheritance, so the credit can't be used. Similarly if there is no inheritance tax due from any beneficiaries if below their CAT Bands.

@RedOnion: By exit tax, do you mean exit tax on ETFs, or only on certain unit linked funds? According to page 2 of this Standard Life PDF, an exit tax credit is allowed against inheritance tax for Irish unit linked investment bonds, but not for UCITS ETFs:

[broken link removed]

Can you confirm that this is accurate?

 

[Marc]

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