Vanguard ETFs. A comprehensive guide for financial advisers

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1 Vanguard ETFs A comprehensive guide for financial advisers

2 The content of this brochure applies to Vanguard ETFs only. 2 Connect with Vanguard > vanguard.com.au >

3 Contents Introduction to ETFs 4 What are ETFs? 4 How do they work? 4 What are the benefits of Vanguard ETFs 5 Buying and selling ETFs 6 Participants in the ETF market 8 Liquidity in ETFs 10 Costs, pricing and distributions 11 Fees and charges 11 Pricing of ETFs 11 Distributions 12 Taxation 13 Domestic ETFs 13 Cross-listed ETFs 13 Using Vanguard ETFs in client portfolios 15 Determining your client s suitability to ETFs 15 Incorporating ETFs in investor portfolios 15 Further information 17 Vanguard ETFs > A comprehensive guide for financial advisers 3

4 Introduction to ETFs Introduction to ETFs Vanguard Exchange Traded Funds (ETFs) are diversified portfolios of securities constructed using an indexing approach that can be readily traded on the Australian Securities Exchange (ASX). What are ETFs? An ETF is a managed fund quoted for trading on a securities exchange. Generally ETFs are constructed as indexed portfolios of shares, bonds* or real estate securities. How do they work? Vanguard ETFs track broad market indices representing a broad diversification of securities for the investor. Their value moves in line with the index they track. For example, a 2 per cent rise or fall in the S&P/ASX 300 Index should result in approximately a 2 per cent rise (before fees and tax) or fall for the Vanguard ETF VAS which tracks that index. ETFs can be bought and sold through brokerage accounts in the same way as shares at any time during exchange hours at intraday prices, rather than end of day prices as with unlisted managed funds. Investors can also use other share trading techniques with ETFs such as buying on margin. ETFs offer investors a unit based share of a managed index tracking portfolio in the same way as a managed index fund. Index management means that the funds seek to track specific market indices, offering the benefits of low operating costs, diversification, potential for tax efficiency, and transparency. INDEX FUND CHARACTERISTICS Diversification Low fees Low portfolio turnover EXCHANGE TRADED FUND INDIVIDUAL SHARE CHARACTERISTICS Continuous pricing Trading flexibility Low execution costs Figure 1. *At the time of writing bond ETFs are not available to Australian investors on the ASX. 4 Connect with Vanguard > vanguard.com.au >

5 Introduction to ETFs What are the benefits of Vanguard ETFs? Low costs The management fees for index-based ETFs are usually significantly less than investing in the same exposure of individually purchased securities. ETFs are also more cost efficient than actively managed funds. Diversification Index funds invest in all or a representative sample of securities in an index and provide a highly diversified investment. Like our traditional managed funds, Vanguard ETFs are constructed using an indexing approach, where an individual investment is pooled with other investors money. This offers investors access to a wider range of investments which may not be accessible otherwise to an individual investor. Potential for tax efficiency Tax can potentially take a large chunk out of investment returns so it pays to invest in funds that are tax efficient. The low turnover of an indexing approach minimises the capital gains distribution impact. This improves after-tax performance and tax efficiency over the longer term. Liquidity The authorised participant s ability to create and redeem ETF securities on a regular basis ensures an underlying depth of liquidity. Unlike unlisted managed funds, investors are able to trade ETFs during ASX trading hours and at a price quoted on the ASX. Transparency The issuer of the ETF provides daily information to the market including the ETF basket and the Net Asset Value (NAV) of the ETF, making ETFs a highly transparent investment option. Vanguard ETFs > A comprehensive guide for financial advisers 5

6 Buying and selling ETFs Buying and selling ETFs ETFs can be bought and sold on the ASX in the same way as shares. Advisers can also access some ETFs through their platform provider (conditional on approvals). The diagram below at Figure 2 represents the process of executing a trade on the ASX via an online broker such as CommSec or E*Trade (the exact terms may differ from one broker to another). The process involves logging into your account and choosing whether you wish to execute a market order, a limit order or a conditional order. Market orders A market order is a buy or sell order which instructs the broker to immediately execute the trade at the best market price. This is not a guaranteed price and you can only execute a market order during trading hours. Limit orders on ETFs are purged at the close of trading each day at which point the trade is cancelled. This type of order will typically not be accepted if the market considers the limit price to be too far away from the prevailing market price of that stock. Limit orders can be amended or cancelled provided the order has not already been executed and only during market closure times. Conditional orders A conditional order is made when you set a trigger price and a limit price. When the share price rises or falls to your trigger price, the broker endeavours to place a limit order into the market on your behalf. There is no guarantee that the order will be bought or sold when the trigger is hit as the order will need to satisfy trading rules once triggered. Limit orders A limit order is an instruction to buy or sell at a specified price or better. Generally limit orders ensure you only pay a price or sell at a price that you are comfortable with. Purchasing an ETF security INVESTOR Login to your brokerage account To buy at market price submit a MARKET ORDER To buy at a price other than what is on the market submit a LIMIT ORDER Locate the ticker code for the ETF you wish to invest in Input the ticker code and the number of securities you wish to purchase to begin trading the ETF Finalise your order Figure 2. 6 Connect with Vanguard > vanguard.com.au >

7 Buying and selling ETFs Primary Market Secondary Market INDEX FUNDS CREATE REDEEM AUTHORISED PARTICIPANTS & MARKET MAKERS TRADE TRADE BROKER, BUY / SELL ADVISER INVESTOR For example HOLD / HEDGE ETF UNITS SHARES 20,000 ETF units = $1.2m 200 shares (basket) = $1.2m Figure 3. Primary Market Secondary Market Executing the trade CREATE AUTHORISED Once you have chosen an order type, you PARTICIPANTS progress to input the amount of securities you wish to purchase & plus REDEEM the ticker code of the security. MARKET INDEX FUNDS Every security quoted for trading on the ASX has a unique three letter identifier commonly called its ticker code. For example Trades are settled on a T+3 basis. That means transfer ETF UNITS SHARES 20,000 ETF units = $1.2m 200 shares (basket) = $1.2m of ownership of the ETF securities and related payments between the buyer s broker and the seller s broker are completed on the third ASX business day after the trade takes place. Primary Market From the point of purchase where the investor places an order via their broker to purchase CREATE ETF securities on the AUTHORISED exchange one of three things happen: 1. the broker uses existing REDEEM ETF units to complete MARKET the INDEX FUNDS transaction; or, MAKERS 2. the broker transacts with appointed ETF market makers who can create ETF units if necessary; or, For example 3. the broker transacts with another broker who has ETF ETF units UNITS on offer. SHARES 20,000 ETF units = $1.2m 200 shares (basket) = $1.2m MAKERS PARTICIPANTS & The trade then settles like any standard transaction BROKER, subject to a three day settlement period. TRADE TRADE BUY / SELL ADVISER HOLD / HEDGE The structure of ETFs ensures the investment generally trades close to its NAV. Because Vanguard ETFs are open-ended (meaning units can be issued or redeemed at any time), wholesale trading participants can create and redeem units in the underlying fund to meet investor demand. This structure supports ETF market liquidity and assists the price to closely track the NAV of the underlying investment portfolio. Secondary Market TRADE TRADE BROKER, BUY / SELL ADVISER HOLD / HEDGE INVESTOR INVESTOR Other trading techniques Stop-loss orders Stop-limit orders Short selling Primary Market CREATE AUTHORISED PARTICIPANTS & REDEEM the trade is executed as a market order MARKET once the INDEX FUNDS MAKERS A stop-loss order can be applied to a trade in which designated stop price is hit. In this type of order you may, or may not get the price you have placed your stop at. For example For example, an adviser puts a stop-loss order at $40 for ETF UNITS SHARES 20,000 ETF units = $1.2m 200 shares (basket) = $1.2m an ETF security. When that security hits $40 on market the order is triggered and becomes a market order. TRADE TRADE BROKER, BUY / SELL ADVISER HOLD / HEDGE A stop-limit order is an order whereby the sale or purchase goes through only if you can achieve the Secondary Market limit price set by the order. For example, an adviser puts a stop-limit order on the sale of an ETF security at $40. When there is demand INVESTOR on market to purchase that security at $40 the order goes through and the ETF security sells for $40. If there is no chance of the security reaching the limit sale price, the order does not go ahead. Short selling is the process of selling shares that are borrowed and is generally used to profit from a decline in the price between the sale and repurchase of an ETF security. Vanguard ETFs > A comprehensive guide for financial advisers 7

8 Participants in the ETF market Participants in the ETF market The ETF market is made up of a primary and secondary market. Primary Market The primary ETF market is made up of three participants: Issuers of ETFs Authorised Participants Market Makers The issuer of an ETF is the fund manager who manages the ETF and its underlying securities (for example Vanguard is the issuer of Vanguard ETFs). The issuer publishes a basket of securities for delivery each trading day to Authorised Participants and swaps this basket when delivered for ETF units. Authorised Participants or APs are authorised trading participants with the ASX that have an agreement in place with the issuer to create and redeem units in an ETF. An AP applies to the issuer for wholesale lots of units called creation units, typically 20,000 securities or more. To settle this application the AP delivers a basket of securities rather than cash in exchange for an equal value of units in ETFs. The required basket for delivery is published every day by the issuer and reflects the investments and value of the underlying fund. Redemptions occur via a similar process, where the redemption is settled with the AP in exchange for a basket of securities of equal value to the ETF securities being redeemed. A market maker s role is slightly different. They provide liquidity to the market by quoting buy and sell prices throughout the trading day. Market makers seek to provide continuous liquidity to the market. The process begins with the issuer distributing the current fund composition to the market every morning, allowing market makers to price the basket of securities underlying the ETF. Market makers place a buy/sell spread around the true value of the ETF and send these prices to the stock exchange as orders. These orders are published to market, and investors can either hit orders to trade with the market maker or send their own orders to the exchange and wait for someone else to hit them. Market maker orders are updated continuously throughout the day to reflect price changes in the underlying securities. Often, participants in the market can fulfil both the market making and authorised participant roles. ETF Fact or fiction? An ETF can collapse in the event of a large redemption - FICTION 1. An AP can only redeem with settled ETF securities, meaning they must have the ETF securities in their possession. This also requires those securities to be released from any stock lending agreement. 2. No one AP can enter an order to redeem the entire amount of ETF securities outstanding. Secondary Market The secondary market is made up of buyers and sellers of ETF securities on a securities exchange. Different parties include: Securities Exchange (for example the ASX) Financial Advisers and Brokers Investors Share registrars The security exchange s primary role is to provide buyers and sellers a platform (or marketplace) to trade ETF securities. The ASX conducts a formal review process of each ETF issuer and product before new ETFs can be quoted on the exchange. Having products that trade on the ASX also means that ETF issuers are subject to ASX market supervision rules. 8 Connect with Vanguard > vanguard.com.au >

9 For example ETF UNITS SHARES 20,000 ETF units = $1.2m 200 shares (basket) = $1.2m HOLD / HEDGE Participants in the ETF market Primary Market Secondary Market INDEX FUNDS CREATE REDEEM AUTHORISED PARTICIPANTS & MARKET MAKERS TRADE TRADE BROKER, BUY / SELL ADVISER INVESTOR For example HOLD / HEDGE ETF UNITS SHARES 20,000 ETF units = $1.2m 200 shares (basket) = $1.2m Figure 4. Primary Market Secondary Market In Australia, ETFs are quoted for trading on the ASX CREATE AUTHORISED AQUA platform. This dedicated market service was PARTICIPANTS launched in 2007 to provide managed funds, ETFs, and & structured products with REDEEM a tailored trading platform and MARKET access INDEX to a FUNDS back-office clearing and settlement service MAKERS offered by the ASX. Financial For exampleadvisers and brokers can trade ETFs on behalf ETF UNITS of their clients through two types of brokerage SHARES 20,000 ETF units = $1.2m 200 shares (basket) = $1.2m services: non- advisory brokers - which include direct orders through an administration platform or online broker, and, full service brokers who can offer advice and guide an investor or their adviser through the ETF transaction process. Investors can trade ETF securities directly via their financial adviser or broker. As ETFs are quoted investments, a share registrar manages the administration for investors such as paying distributions, providing distribution and tax information and allowing investors to elect and change their tax file number status and distribution reinvestment plan elections. Computershare is the share registrar for Vanguard ETFs. The creation and redemption process To create new ETF units, the AP applies for new ETF securities to be created in multiples of creation units (typically one creation unit is 20,000 securities). Only APs can create or redeem ETF units with the issuer. In return they deliver the basket of securities specified by the issuer. On settlement, the AP then has an inventory of ETF securities that can be sold on the ASX (the secondary trading market ). The redemption process works in the opposite way: the AP applies to redeem securities in multiples of creation units and in return receives a basket of securities. This creation and redemption process is referred to as an in-specie or in-kind transaction. Throughout the trading day, market makers continuously provide on-screen quotes BROKER, for both buy and sell orders. They can also mediate ADVISER INVESTOR for investors wanting to buy or sell large parcels of ETF securities, effectively providing an additional layer of liquidity beyond that shown on-market. TRADE TRADE BUY / SELL HOLD / HEDGE ETF spreads The spread is the difference between the bid price and offer price. A market maker s role is to provide liquidity in trading volume and quote within agreed spreads. Market makers earn their revenue from trading and have a strong motivation to maintain tight ETF bid-offer spreads. Better spreads and liquid markets are more attractive to investors, increasing the demand for securities which in turn creates higher trading volumes. In addition, the ASX provides incentives via ASX fee rebates if market makers maintain certain spread levels. Where spreads are not attractive the market maker may be able to earn a larger margin on each trade. However, this can stifle long-term investor interest and demand and may result in lower amounts of business in the longer term. Globally there has been rapid growth in ETFs issued and traded. Spreads can also be affected by market uncertainty. In the case where there is a very high degree of uncertainty in the sharemarket, spreads on all trading securities in that market may be affected, including ETF securities. However, unlike shares, an ETF has a well-defined underlying value - the NAV. The NAV of the underlying Vanguard index fund is published daily on the Vanguard website. This provides both investors and market participants with daily information on the ETF s value. Vanguard ETFs > A comprehensive guide for financial advisers 9

10 Liquidity in ETFs Liquidity in ETFs One of the primary advantages of ETFs is that there are two sources of liquidity. There is liquidity on the market as defined by the securities on issue and the depth of trading on-market. There is also liquidity that sits with the issuer and the ability to create or redeem ETF securities to meet investor demand this liquidity reflects the open-ended nature of ETFs and the liquidity of the securities held by the ETF. Where is liquidity found? ETFs are open ended: for example, if liquidity in the market was $5 million and an investor wanted to purchase $10 million of Vanguard ETF units, they could contact an AP, who has the option to create a further $5 million worth of ETF units with Vanguard and then sell directly to the investor. The securities required to deliver in the creation process are readily available (for example ASX / S&P 300 securities) which supports the liquidity of the products to meet demands from buyers and sellers. Conversely, if an investor wanted to sell $10 million worth of Vanguard ETF units, the AP would provide a purchase price for the securities with the investor then redeem the $10 million worth of ETF units with Vanguard. It is the ability to create and redeem ETF units with the issuer that makes ETF s such an innovative and flexible investment vehicle. How can an ETF s liquidity be measured? A good measure of ETF liquidity is the liquidity of the underlying stocks in the index the ETF tracks. Unlike shares, an ETF s liquidity should not be determined by trading volume, even a relatively small ETF will be liquid if there is good liquidity in the securities that make up the ETF units. What motivates APs and market makers to maintain liquidity? AP s operate at arms-length from ETF issuers. They are remunerated by their own market activities. Market makers in Australia are offered an incentive to maintain spreads and liquidity on market via a financial incentive offered by the ASX. APs and market makers are active market participants and earn revenue through the bid/ask spread and volumes that they trade. AP s earn revenue by acquiring ETF s in the primary market at the ETF s NAV and then selling in the secondary market at a margin above the NAV. Similarly they can acquire ETF securities in the secondary market below the NAV and redeem in the primary market. Competition between the APs quoting each ETF security helps to ensure that bid/ask quotes for the ETF securities are consistent with the NAV. APs that quote wide spreads will be undercut by other APs and as a result will not have competitive trades available for the market. How does Vanguard select market makers? In selecting market makers for Vanguard ETF s, Vanguard focuses on companies trading ETF s in Australian and international financial markets. The companies selected by Vanguard currently operate as market makers in existing Australian ETF securities quoted on the ASX and have agreements with the ASX to operate in this capacity. Internationally, the market makers selected will also have experience in the respective ETF markets, such as the New York Stock Exchange. ETF Fact or fiction? ETF s are derivatives - FICTION* A derivative is a financial instrument (or an agreement between two parties) that has a value that is derived from one or more underlying assets and is not a stand alone asset since it has no value of its own. An ETF could be considered a derivative as its value is derived from the underlying assets that it holds, however, it is not a derivative as it doesn t satisfy the second condition. The ETF actually holds the underlying assets in trust for every ETF unit that gets issued. *Note: Synthetic ETF s may use derivatives in their investment strategy. 10 Connect with Vanguard > vanguard.com.au >

11 Costs, pricing and distributions Costs, pricing and distributions Fees and charges Management fee The management costs for Vanguard s ETFs incorporate all fees and costs involved in managing the ETF and deriving investment returns, other than transaction and operational costs. They include: the responsible entity s fee; the custodian s fees (excluding transaction-based fees); accounting and audit fees; index license fees; registry service fees; and any other recoverable expenses under the constitution of the fund, such as the cost of preparing and amending the constitution, the cost of producing the Product Disclosure Statement (PDS) or Prospectus, the cost of investor meetings, postage and other fund administration expenses. The Managed management Index Fund cost Costs is accrued within the unit price on a daily basis 1. Management Brokerage charges Expense Ratio (MER) Investors will incur customary brokerage fees and commissions when buying and selling ETF securities on Buy/Sell Spreads the ASX. The amount of this fee varies from broker to broker and can depend on the platform through which the transaction is made. Managed Index Fund Costs Management Expense Ratio (MER) Figure 5. Buy/Sell Spreads Exchange Traded Fund Costs Management Expense Ratio (MER) Brokerage Fees Bid/Ask Spreads Pricing of ETFs Net Asset Value (NAV) The NAV of an ETF is calculated and published daily by the issuer. The NAV is based on the closing market prices of the securities which make up the ETF units. The exact calculation is determined by the funds constitution but generally reflects the market value of the investments less deductions for fees and expenses. The market buy and sell quotes of the ETF can differ from the NAV which is calculated at the end of the day. There can be a number of factors influencing the current market price including the share price movement of the securities in the index used by the ETF and investor demand for the ETF. Quotes on international ETFs (also known as Cross Listed ETFs) can also be influenced by currency movements and share price movements in foreign securities exchanges. The role of arbitrage in ETF price setting The trading price of an ETF is established throughout the trading day. APs calculate the value of the ETF securities continuously throughout the day. When the price of the ETF deviates from the value of the underlying securities there may be an arbitrage opportunity. If the underlying securities are trading at a lower price than the ETF securities, arbitrageurs will tend to buy the underlying securities, exchange them for new ETF securities, and then sell the ETF securities on the open market for a profit. If the underlying securities are trading at higher values than the ETF securities, arbitrageurs buy ETF securities on the open market, redeem those securities in exchange for the underlying securities, and then sell the individual securities on the open market for a profit. Exchange Traded Fund Costs 1 For full Management details of applicable fees and costs, please refer to the current PDS or Prospectus. Expense Ratio (MER) Brokerage Fees Vanguard ETFs > A comprehensive guide for financial advisers 11 Bid/Ask Spreads

12 Costs, pricing and distributions Costs, pricing and distributions (continued) Active arbitrage activity among APs and market makers keeps ETF securities trading at a range that is close to the value of the underlying securities. This is beneficial for investors trading the ETFs on the ASX as they can have higher confidence that the on-market price closely matches the value of the index that the ETF represents. This arbitrage mechanism is one of the main advantages of ETFs over Listed Investment Companies (LICs) which can trade at significant premiums or discounts to their NAV. Bid price The bid price is the price at which participants on the secondary market are willing to purchase ETF units. Offer price The offer price is the price at which participants on the secondary market are willing to sell ETF units. While at any time a market participant may have the best bid or offer on an ETF, it is the role of the market maker to ensure there is always a bid and offer, and to ensure that the difference (or spread) between the quote to buy (bid) and sell (offer) are within a certain range (in percentage terms). The ASX rewards market makers through a rebate program for maintaining bid/offer quotes inside these desired spreads. Distributions The expected returns of Vanguard ETFs are generally aligned to the index returns (before fees) of the index the respective Vanguard ETF tracks. Returns generally come in the form of income and growth. Investors in Vanguard ETFs receive a distribution at the end of each distribution period (which is generally quarterly but can vary). The amount received is based on the amount of Vanguard ETF securities the investor holds and the declared distribution per security. The distribution will have separate taxable components such as dividends (potentially including franking credits), interest and realised capital gains. Growth comes from any increase in the value of the underlying portfolio s assets and will be reflected in market price movements. This return is only realised on the sale of the Vanguard ETF securities. ETF Fact or fiction? ETFs are only for market-timers - FICTION Some believe that ETFs are only appropriate for speculators, market-timers, or other investors with short time horizons. However, ETFs may benefit long-term investors even more as the ETFs low expense ratios can more than offset commissions and spreads over time. 12 Connect with Vanguard > vanguard.com.au >

13 Taxation Taxation Vanguard ETFs offer investors potential tax efficiencies due to their buy and hold approach. As index portfolios, Vanguard ETFs (and index funds) tend to realise fewer capital gains than actively managed funds. This is due to a low turnover in the underlying securities in the fund. Distributions Domestic ETF Distributions to which an investor becomes entitled to during a financial year form part of an investor s assessable income even if payment occurs after the end of the financial year. Cross-listed ETF Distributions an investor receives during a financial year form part of an investor s assessable income. Domestic ETFs Domestic ETFs are ETFs which only trade on their local share market in Australia those exclusively quoted on the ASX. Cross-listed ETFs Cross-listed ETFs (or International ETFs) are ETF securities that are sold on a foreign securities exchange, as well as on their local exchange. Vanguard s cross-listed ETFs are quoted on the ASX as Chess Depositary Interests (CDIs). CDIs are Australian financial instruments designed to give Australian investors rights and entitlements to the underlying ETF security offered in overseas markets. A Depositary Nominee, CHESS Depositary Nominees Pty Limited, holds title of the underlying ETF securities on behalf of CDI holders. Vanguard s domestic and cross-listed ETFs are treated differently for tax purposes. The table to the right discusses how tax is applied and treated in various circumstances. This is a guide only, for more detailed information on taxation of Vanguard ETFs please refer to the PDS or Prospectus for the relevant Vanguard ETF which can be found on Vanguard s website. Tax Credits Capital Gains Any franking credits received from the underlying securities are passed on with distributions to the investor. Generally, franking credits may be offset against Australian income tax payable for the relevant year in the investor s tax return. The fund may incur capital gains which will be distributed to investors. Also, if the investor sells ETF securities on-market, they may be liable for capital gains tax on gains realised in the sale. Distributions from a US listed ETF are subject to US withholding tax. The withholding tax rate can be limited to 15% but investors need to fill out a W8-BEN form to access this rate (refer to Tax forms ). Australian resident investors may be able to claim a tax offset for the US withholding tax paid. If the investor sells cross-listed ETF securities they may be liable for capital gains tax on gains realised in the sale. Estate Tax Does not apply US estate tax may apply upon the death of an investor however the amount of tax may be reduced under an Australian/US estate tax treaty and certain exemptions exist depending on the legal structure of the investor. Non-Assessable Distributions A distribution from an ETF may include certain tax-free or tax deferred amounts. If assessed under the capital gains tax provisions, Australian investors may not be assessed on the tax-free or tax-deferred components of the distribution, however these amounts may have capital gains tax consequences when the investor sells their ETF securities. In very limited circumstances a distribution from a cross-listed ETF may include a return of capital. If assessed under the capital gains tax provisions, Australian investors may not be assessed on the return of capital component of the distribution, however this will have capital gains tax consequences when the investor sells their cross-listed ETF securities. Vanguard ETFs > A comprehensive guide for financial advisers 13

14 NEM (If you marked the Other box please indicate type of beneficial owner as shown on Investor Guide) OMB No (Rev. Feb 2006) Dept. of U.S. Treasury If you are a corporation, enter the country of incorporation. If you are another type of entity, enter the country under which laws you were created, organized, or governed. Under penalties of perjury, I declare that I have examined the information on this form and to the best of my knowledge and belief it is true, correct, and complete. I further certify under penalties of perjury that: 1. I am the beneficial owner (or am authorized to sign for the beneficial owner) of all the income to which this form relates, 2. The beneficial owner is not a U.S. person, 3. The income to which this form relates is (a) not effectively connected with the conduct of a trade or business in the United States, (b) effectively connected but is not subject to tax under an income tax treaty, or (c) the partner s share of a partnership s effectively connected income, and 4. For broker transactions or barter exchanges, the beneficial owner is an exempt foreign person as defined in the instructions. Furthermore, I authorize this form to be provided to any withholding agent that has control, receipt, or custody of the income of which I am the beneficial owner or any withholding agent that can disburse or make payments of the income of which I am the beneficial owner. 27/05/09 Computershare Investor Services Pty Limited Taxation Taxation (continued) Tax Forms In Australia, Vanguard cross-lists ETFs quoted on a US stock market (the NYSE). For this reason investors need to complete a separate tax form to claim a reduced tax treaty rate for distributions. A W-8BEN form has to be completed for each cross listed ETF purchased. For Australian investors, submitting the form means that distribution income will be taxed at a maximum withholding tax (WHT) rate of 15 per cent. If the investor does not submit the form, the distribution will have 30 per cent WHT deducted. Some investors such as certain government organisations may be eligible Do not use this form for: for a WHT rate of 0 per cent. These investors will have to apply directly to the US Internal Revenue Service. The details on the W-8BEN form will have a life-span of three years. When the three years is nearly up, investors will be sent a new form to fill out and submit. The W-8BEN form needs to be completed for each cross-listed ETF purchased (using the same SRN/HIN). The share registrar coordinates this and files the forms on behalf of investors. A US tax return will not be required if you have lodged a valid W-8BEN form. If investors believe they are eligible for a further refund of U.S. tax withheld, they should consult their tax adviser. Form W-8BEN Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding (Section references are to the Internal Revenue Code) Instead, use Form: A U.S citizen or other U.S person, including a resident alien individual.... W-9 A person claiming that income is effectively connected with the conduct of a trade or business in the United States... W-8ECI A foreign government, international organization, foreign central bank of issue, foreign tax-exempt organization, foreign private foundation, or government of a U.S possession that received effectively connected income or that is claiming the applicability of section(s) 115(2), 501(c), 892, 895, or 1443(b)...W-8EXP or W-8ECI Note: These entities should use Form W-8BEN if they are claiming treaty benefits or are providing the form only to claim they are a foreign person exempt from backup withholding. A person acting as an intermediary/fiow-through entity...w-8imy How to complete the W8-BEN Form The diagram to the right details nine easy steps to complete the W-8BEN form. This form can be found on Computershare s website: computershare.com.au 1 Name and Mailing Address The information in this section reflects the name and mailing address of the registered holder of the securities. 2 Type of Beneficial Owner Tick one box that applies to the beneficial owner. If the beneficial owner is an Individual, tick the Individual box. If the beneficial owner is a Corporation, tick the Corporation box. If the beneficial owner is neither an Individual nor a Corporation tick the Other box and choose from the following categories (See Notes on Trusts below): T - Complex Trust S - Simple Trust G - Grantor Trust P - Partnership D - Disregarded Entity E - Estate F - Private Foundation X - Tax Exempt Organization as approved by the US Internal Revenue Service V - Government B - Central Bank of Issue N - International Organization 3 Claim of Treaty Benefits (i) Eligible Individuals If you indicated the type of beneficial owner is an Individual you must tick box 9a AND enter the country of permanent residence. (ii) Eligible Non-individuals If you indicated the type of beneficial owner is not an Individual you must tick box 9a AND enter the country of permanent residence AND tick box 9c. 4 Signature The signature of the beneficial owner or an authorized signatory of the beneficial owner must sign here. All correspondence to: Computershare Investor Services Pty Limited GPO Box 2975 Melbourne VIC 3001 Australia Enquiries (within Australia) (outside Australia) Facsimile web.queries@computershare.com.au MR JOHN SAMPLE FLAT 123 SAMPLE STREET Securityholder Reference Number (SRN) SAMPLE 1STREET SAMPLE STREET SAMPLETOWN VIC 3030 *I * I I N D Use a black pen. Print in CAPITAL letters A B C X inside the grey areas as shown in this example. Form W-8BEN Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding Part I. Identification of Beneficial Owner (Refer to Investor Guide for completing Form W-8BEN) Please mark the box that indicates your status. Country of Incorporation Individual Corporation Other 9 2 Name of beneficial owner (if the beneficial owner is not the same as the registered holder as shown above, please write the beneficial owner details in the boxes below) U.S. Taxpayer Identification Number (TIN), if any 8 Permanent Residence Address (Refer to Investor Guide for completing Form W-8BEN) DO NOT ENTER YOUR AUSTRALIAN TAX FILE NUMBER (TFN) Unit Street Number Street Name (if your permanent residence address is not the same as the registered address as shown above, please write it in the boxes below) 7 City/Town/Suburb State Postcode Country Part II. Claim of Tax Treaty Benefits, if eligible Important! If eligible, Non-individuals must tick box 9a AND box 9c AND enter country of residence. Individuals must tick box 9a AND enter country of residence. The beneficial owner Country 9a 9c The beneficial owner is a non-individual, derives is a resident within the the income for which the treaty benefits are meaning of the income tax claimed and, if applicable, meets the limitation treaty between the United on benefits treaty provision requirements. 3 States and the country identified to the right. Part IV. Certification - Sign Here Signature of beneficial owner or authorized signatory Capacity in which acting Contact Details - Phone Number Date (day/month/year) / 6 / Send form to Computershare DO NOT SEND TO THE IRS (see reverse for mailing instructions). V E U 0 1 A W 8 5 Capacity in which acting If this form is completed by an agent acting under a duly authorized Power of Attorney, the form must be accompanied by the Power of Attorney (if not already noted by the registry). Non-individual - this form must be signed by an authorized representative or officer of the beneficial owner and the capacity in which acting field must be completed, e.g., Director. W Country of Incorporation If you are a corporation, enter the Country of Incorporation. If you are another type of entity, enter the country under which laws you were created, organized or governed. 8 U.S. Taxpayer Identification Number (TIN) If you have a U.S Social Security Number or a U.S Employer Identification Number, enter it here. Do not enter your Australian Tax File Number. 7 Residence Address of beneficial owner/s If your permanent residence address is not the same as the mailing address printed on the Form W-8BEN, you must write your permanent residence address here. Do not use a P.O. Box or care-of address. Generally, your permanent residence address is the address in the country where you claim to be a resident for income tax purposes. 6 Contact Details & Date Enter your phone number so we can phone you if required. Enter the date the form was executed. Joint Ownership Each beneficial owner of a joint holding must complete and return a separate Form W-8BEN. Each form must be individually signed in order to be valid. W Notes on Trusts: U.S law may interpret trusts differently to that applying in an Australian or other jurisdiction. The descriptions below are provided as a general indication of the characteristics of the types of trusts referred to in the Form. You are advised to obtain your own independent professional advice. Simple Trust: Governing documents requires distribution of all income to current beneficiaries and does not distribute or accumulate income or gains for charitable purposes and the trust does not, in fact, distribute any capital or accumulated income. Grantor: (a) The power to revest title to the trust property absolutely in the grantor is exercisable either (i) solely by the grantor without the approval or consent of any other person, or (ii) with the consent of a related or subordinate party who is subservient to the grantor; or (b) during the lifetime of the grantor, trust distributions (whether income or corpus) may be made only to the grantor or grantor s spouse; or (c) trust distributions are taxable as compensation for services rendered. Complex: Governing documents provide for the accumulation of income for future distributions or may accumulate income or gains for charitable purposes. Figure 5. V E U 14 Connect with DO Vanguard NOT FAX THIS > FORM vanguard.com.au >

15 Using Vanguard ETFs in client portfolios Using Vanguard ETFs in client portfolios The practical applications of ETFs are varied and, depending on your client s preferences and profile, you can tailor tax efficient, low cost portfolios using ETFs which can stand alone or complement an existing portfolio. ETFs can be thought of as a different way of accessing Vanguard s investment management approach. Vanguard ETFs and their equivalent managed index funds are both managed using Vanguard s time tested index investment management. Determining your client s suitability to ETFs How often your client wishes to add to their investment. You should make clients aware that brokerage fees apply when buying and selling ETFs. Brokerage fees are typically a fixed dollar amount per trade compared to the buy/sell spread charged on a traditional (managed) index fund. A fixed dollar brokerage fee for an ETF can be more cost effective for investors making large, infrequent purchases. However, investors making ongoing, smaller contributions may be better suited to an investment in a managed fund where costs are based on a small percentage of each contribution instead of a fixed amount per purchase. The importance of trading strategies to your client. ETFs, like other market quoted investments, can use sophisticated trading strategies (like limit and stop-loss orders) and can also be included in margin lending programs. Trading flexibility is a key benefit of ETFs, but not all investors need this flexibility in their investment strategy. Some strategies which require regular transactions, like dollar cost averaging, may not be as cost effective with ETF investments owing to brokerage costs. Incorporating ETFs into investor portfolios Reducing risk - diversification and asset allocation in portfolios Clients looking to improve diversification or looking for a well diversified portfolio can be well suited to ETFs. Many offer a diversified investment, tracking all or a representative sample of the companies, countries or elements of the index it tracks. Some ETFs hold thousands of securities so a single unit purchase can instantly diversify an investor s portfolio in the particular asset class or regional ETF in which it invests. This diversification can serve to reduce individual security risk in a client s portfolio. For example: An investor invests $100,000 in the two international Vanguard ETF s (VEU & VTS) with a 50:50 split. This investor will gain coverage of approximately 93 per cent of the world sharemarkets at a cost of just 0.14 per cent p.a.* *Does not include brokerage costs, costs correct as at date of publication. Use ETFs as core holdings in a portfolio An ETF is an ideal core holding in an investment portfolio due to its low cost, tax efficient structure and returns that closely match the benchmark return. It also serves to diversify your clients core holdings. A common investment strategy is to use ETFs to construct a robust, diversified core portfolio, where the investor can have confidence that the performance of the index benchmark will be closely tracked. Then, investors can seek above-benchmark (alpha) returns by investing other money in the specific securities or market sectors that they think will outperform others. Vanguard ETFs > A comprehensive guide for financial advisers 15

16 Using Vanguard ETFs in client portfolios Using Vanguard ETFs in client portfolios (continued) Vanguard ETFs investment portfolios hold a broad spread of securities within an index in order to track the overall performance of the index with very low levels of portfolio turnover. Lower portfolio turnover results in lower costs to the investor and generally produces more favourable tax outcomes. Cost saving applications Investors interested in reducing their total investment management costs can look to ETFs as a means of lowering costs. In a core-satellite structure ETFs can be used as the core component of the portfolio to lower total portfolio fees while the satellite component can be restructured to capture investment opportunities through specific shares, managers, or tactical investments. ETFs can also be used as short-term investments during a portfolio restructure. In fact, one of the largest hidden costs to investors can be the cost of being out of the market during a portfolio restructure. ETFs low management costs and low trading costs make them a cost-effective temporary holding to maintain exposure to equity markets while you are working out the longer term asset allocation. Tax planning with ETFs Distributions from ETFs will largely reflect the dividends paid by the underlying securities in the investment portfolio and may also include franking credits. Unlike actively managed funds with high levels of portfolio turnover, Vanguard s index management approach aims to minimise portfolio turnover and hence should tend to generate relatively lower levels of realised capital gains to be distributed as income. Rebalance a portfolio The success of an investment strategy relies on having a strategic asset allocation that meets the needs and objectives of the client. Over time portfolios can move away from the strategic asset allocations as the value of different assets change. Without management, or rebalancing, the portfolio soon moves too far from the strategic asset allocation and jeopardises the chances of meeting the client s objectives. ETFs can be used to quickly and easily correct these imbalances by purchasing the asset types required to rebalance the client portfolio. Incorporate into a Self Managed Super Fund (SMSF) ETFs are a useful investment option for retirement planning. SMSF trustees typically have a preference for direct shares over managed funds due to costs. The disadvantages of this approach are the difficultly and expense of creating adequate diversification in the portfolio and the greater administration involved in holding multiple direct shares. ETFs provide a great alternative to using direct shares offering the diversification, tax effectiveness and low cost benefits of index funds, with the control and flexibility that comes with direct share ownership. The strategy of using ETFs as the core of an equity portfolio and directly held shares or actively-managed funds as satellites may appeal to many SMSF trustees, depending upon their circumstances. Given that ETFs are traded in the same way as shares, ETFs can also be used to easily rebalance your clients SMSF exposure to equities when appropriate. 16 Connect with Vanguard > vanguard.com.au >

17 Further information Further information Available at vanguard.com.au/etfs Vanguard ETF Plain Talk Guide Vanguard ETF PDS and Prospectus Vanguard ETF Overview Flyer Vanguard ETF Product Profiles Vanguard ETFs At A Glance Vanguard ETF Fee Comparision Calculator ASX Website Vanguard ETFs > A comprehensive guide for financial advisers 17

18 This page has been left intentionally blank.

19

20 Connect with Vanguard The indexing specialist > vanguard.com.au/etfs > Past performance is not an indication of future performance. In preparing the above information, individual circumstances, for example tax implications, have not been taken into account and it may therefore not be applicable to an individual s situation. Before making an investment decision, you should consider your clients circumstances and whether the above information is applicable to their situation. Vanguard Investments Australia Ltd (ABN /AFS Licence / RSE Licence L ) is the product issuer. Vanguard ETFs will only be issued to Authorised Participants, that is persons who have been authorised as trading participants under the ASX Operating Rules ( Eligible Investors ). Retail investors can transact in Vanguard ETFs through a stockbroker or financial adviser on the secondary market. Investors should consider the relevant Product Disclosure Statement (PDS) or Prospectus in deciding whether to acquire Vanguard ETFs. Retail investors can only use the relevant PDS or Prospectus for informational purposes only. You can access these documents at vanguard.com.au Vanguard Investments Australia Ltd. All rights reserved. Vanguard, Vanguard Investments and the ship logo are the trademarks of The Vanguard Group, Inc. VETFCGA 1011

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