3a: Are index funds really always better than ETFs?

Banks, Insurances & Third Pillar
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I came across a Finpension article which says that ETFs should not be used in 3a:
https://finpension.ch/en/knowledge/why-etfs-are-only-second-choice-in-pillar-3a/

This article makes sense to me so far. But in my understanding, it is incomplete or even missleading: index funds with pension share classes as used in 3a make sense for some asset classes where there would be a non-reclaimable withholding tax (e.g. for US classes).

But for asset classes that do not have such withholding taxes, it is not always clear to me why index funds are always better than ETFs. Recently there was an interesting discussion regarding EM funds, where the outcome was in my understanding that the the iShare ETF is “better” than the CSIF:

While digging into this topic a bit further, I also came across the following article, which also sounds reasonable to me:

Do you think the Finpesion article is fully correct? Or is it more some type of marketing material to push their solution because they only use index funds?

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I think both companies talk about advantages of their solutions.

The question you need to ask is what costs would you incur when you use their solutions

For FP, you should use strategies which include low spread index funds. Since stamp duty is zero and TERs are very low, there wouldn’t be any other costs

For True wealth , you should use strategies with low TER ETFs.

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True Wealth does seem appealing, however, somehow despite all the information, I can’t find what ETFs they actually use (and it seems like unlike finpension/viac where you have some amount of choice) you don’t here, TrueWealth does it all for you (and that is why they don’t tell you which ETFs I guess). Not sure I like that.

The stamp duty and FX markup are in my eyes irrelevant, they are one-off, versus 0.15% average TER on the ETFs they use compared to 0.39% or 0.41% for the ‘all-in’ fee of finpension and viac every year until age 60. But then you lose 15% on dividends, so if you assume 2% dividends, 15% of that is 0.3% so suddenly if you add that as a ‘cost’ to the ETF version you are at 0.45%. But TrueWealth say “For this reason, we use index funds for some important investment categories in Pillar 3a” - which ones? So again I am back to the point that it seems they don’t actually show you what they are doing exactly. E.g. if they use index funds that don’t have to pay the witholding tax and you go 100% for a All World, then you’d be cheaper with them. But if this is not one of the “important investment categories” then you lose that withholding tax.

I couldn’t find how they came up with a) holding iShares EM in the first place (as I said above I found no information on any possible funds on the site) and b) the 0.24%.

But yea, if anyone could link to where exactly one can see which ETFs they use.

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There is no dividend loss because they use Pension funds wherever applicable

Regarding the instruments -: on their website, under the sample portfolio you can see all instruments. See example of highly aggressive portfolio

I think True wealth is trying to be transparent

IMG_4129
IMG_4129828×1142 124 KB

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All details about the instruments can be checked here (make sure to select “3a” top right of the list):

One well hidden thing is disabling currency hedging: when clicking to “Investment preferences” top right, you can fully toggle off hedging.

I have adjusted my personal investment allocation and checked all asset classes. It looks like they cover everything with pension funds where needed (using a lot of weight on US). Half a year ago or so, this was not the case, they used some ETFs for US classes and also forced you for currency hedging in some cases. Looks like they are on the right path, but the UI could be a bit simple. Sometimes I am a bit overwhelmed with all the information visible


Ah, the TER for the current allocation is visible on the first tab below “Total costs”.

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My view on the arguments of Truewealth:

One advantage of ETFs is their tradability on the stock exchange,

Pillar 3a is a long term investment, there is no need be able to trade multiple time a day.

widely used outside Switzerland

And what is the point of this argument for a Swiss based investor? Index funds are also widely use outside Switzerland

are very cost-efficient.

Index fund are also very cost-efficient if you take into account trading fees, stamp duty and foreign taxes

These are referred to as issue or redeem spread or similar in the respective factsheets of the index funds and are often comparable with the bid/ask spreads of ETFs.

So, it’s the same

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This is very useful, thank you.

You can actually be very specific in what you want given their parameters, not sure how to identify which funds are pension beneficial, but you can put 99% equity and 100% US and get the CSIF (CH) III Equity US Blue - Pension Fund QB which by name suggests you don’t pay withholding tax, and has a TER of 0.15% and benchmarks to MSCI USA which is almost on par with S&P 500 over the last 3 decades. Probably the best you can do. And yes, it’s all US, but you can always weight your personal investments to balance out the fact that your 3a is 100% US.

So yea, this actually looks really good. I would go for them if I weren’t tied up amortizing my 3a contributions. But I could transfer the older 3a accounts. Anyway, thanks again!

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Thanks for your comments on these points. I would like to collect here the optimal solution not pro or against one or the other provider. I think we are all in the same boat: we want to the most optimal solution for us.

I would appreciate if you could do the same type of check with the above linked finpension article. Or do you think ETFs are really always the best choice for 3a?

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Index funds are always the best choice.

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Counterintuitively, the WHT-free US stocks funds are the worst you can do with your 3a. Why? Because you can easily get a full tax credit for it in taxable accounts. Just hold a US domiciled ETF on US stocks.

You can not get tax credit on IE funds. Instead of paying twice in taxable (foreign WHT + Swiss tax), pay only once in 3a (foreign WHT).

So the non-US stock allocation of your portfolio goes into 3a first. Edge cases apply, of course.

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To be honest, I am not sure how this statement adds value to the discussion here. First, are you talking about exchange traded funds or index funds? I assume index funds. In that case, why is should this always be the case? For example when the index fund has a higher TER than a corresponding ETF, why should it still be better? Or for the case when the index fund has a high redemption fee, it should also be considered in my opinion (see linked thread from my first post above about EM funds).

I would really like to focus on facts, not on personal opinions.

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I basically agree here, but the issue is “resolved” if you are using “pension fund” share classes in 3a for such asset classes (which is the case for all major 3a providers like Finpension, Viac or Truewealth).

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No, it is not. This was discussed at length:

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I don’t have any IE funds, but I see your point.

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Do you do 3a? Do you have anything that has WHT (L1, L2) that you can’t credit? Are you not anything strange like a US person?

Then it goes into 3a. Else you might be right, and it doesn’t apply to you.

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Actually, I only hold US and CH stocks. But if I would hold other, I would hold it via VXUS or VT. Not IE based funds.

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Yeah, there isn’t much tax difference between VXUS and IE funds, since the additional US WHT on VXUS can be credited. Fee wise US funds are superior. Estate tax is an annoyance though.

What I consider on top of all this, is that I would rather those 15% go to the place I live in (municipality, canton, country) than feed the far away US government. But I’ll have to consider the fee difference my personal donation to the fund manager’s new Ferrari.

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Just to get the discussion back on topic: I believe @locenad is not raising the topic of what to invest in 3a or taxable. The topic is pension funds vs. ETFs within 3a (and/or VB) accounts: What’s better?

locenad, feel free to correct me if I’m wrong :smile:

I find this Finpension article rather useless: “3a is for income investing, not for capital gains, therefore WHT matters most, therefore use pension funds only” is misleading, frankly, especially for guys investing primarily in equity. And no mentioning of TER vs. WHT vs. tracking error etc.

It would be way more useful if 3a providers could provide actual, detailed cost & performance comparisons of pension funds vs. ETFs instead of biased simplifications

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For all practical purposes as an investor what matters is

For index fund

  • what’s the entry /exit spread
  • What’s the TER
  • What’s the tax advantage from WHT perspective
  • What’s the stamp duties (zero)
  • Other commissions / fees

For ETF

  • what’s the spread
  • what’s the TER
  • What’s the tax advantages
  • What’s the stamp duties
  • Other commissions / fee

So it’s not about index fund vs ETF. It’s about which fund vs which ETF.

From WHT perspective (applicable to US and Japan), I believe only pension funds have possibility to get special treatment. That’s why all providers use pension funds. ETFs don’t have that privilege and hence no provider is using them

For Emerging markets -: both are equivalent from tax perspective because there is no tax advantage for either one of them. So it comes down to spreads, duties & costs and TERs. Nothing else matters.

———-/

Now let me try to make a comment on Fp‘s article about income vs capital gains in pension assets. Their comment might not make sense if we look at this in isolation.

BUT if you think about asset allocation. And let’s say your total assets are X (in pension assets) + Y (in taxable accounts).

It is always better to have high INCOME assets in X and high capital gains assets in Y. This is because pension assets are taxed at withdrawals while income in Y assets are taxed annually.

I tried to do this simulation for myself for IBKR + 3a accounts and concluded that if I want to hold any bonds, then they should be in 3a plans. See here. So all my bonds are actually in pension assets.

For someone who doesn’t hold any bonds, they might want to consider VTI in IBKR while SPI in 3a instead of other way around. Reason being SPI has high dividend as part of return while VTI comes with lower proportional. These are just examples but hope the directional point makes sense

I think this is what they are trying to say. But they didn’t really explain it very well.

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I think we need to consider not looking at WHT in isolation, but rather at the total costs of a fund. When comparing index funds vs. ETFs within 3a, marginal tax rates don’t matter

Lets look at Emerging Markets:

Index fund:

0.39% Finpension fee + tracking error 0.14% - WHT benefit (0%) = 0.53% (excl. 1.24% redemption fee)

ETF:

TER 0.18% (Truewealth ETF) + 0.06% tracking error - WHT benefit (0%) = 0.24% (excl. 0.075% stamp duty and 0.1% FX markup at purchase)

So would anyone care to explain why holding Emerging Markets with an ETF at Truewealth isn’t always the better choice vs. the EM index fund at Finpension?

Of course, the relevant variable here is actually not index fund vs. ETF, but Truewealth vs. Finpension.

So upcoming thread: Truewealth vs. Finpension: The ultimate showdown :smile:

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