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Synthetic S&P 500 Trackers

Index tracking funds and ETFs
AWOL
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Synthetic S&P 500 Trackers

#510307

Postby AWOL » June 28th, 2022, 4:11 pm

So... the US withholding tax that reduces the returns on ETFs is annoying me. Sure I could replicate the index but that would work out more expensive so I've been wondering if Synthetic ETFs may be the way to go. Sadly they don't appear to give any additional benefit regarding dividend tax however they do have a decent performance record.

Has anyone researched this area or experience of it? With multiple counterparties these days the risks seem to be well managed so I am tempted by the idea of synthetic ETFs as a way to avoid withholding tax. I am mainly thinking about investments that will be outside a tax wrapper.

SPXD and i500.L have caught my eye and although I500 doesn't seem to be on HL it looks like it is on my main brokers platform.

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Re: Synthetic S&P 500 Trackers

#510320

Postby rhys » June 28th, 2022, 5:05 pm

I avoid all synthetics. I'm much more worried about counterparty risk in a market collapse than with any small cash cost from withholding taxes.

Have you checked liquidity of your proposed choices? I ask since some have quite significant bid offer spreads. Conversely on VUSA and IUSA I can make money on very small price movements.

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Re: Synthetic S&P 500 Trackers

#510381

Postby AWOL » June 28th, 2022, 6:57 pm

So far I have avoided synthetic trackers however I am thinking that many institutional investors are comfortable to invest in them and they have attracted a lot of money and ran for a long time now without calamity.

A single counterparty cannot be more than 10% of the ETFs NAV under UCITS rules. This doesn't make counterparty risk a non-issue but it does relegate it to being another tail risk amongst many that investors ignore every day.

The spreads on both ETFs are small (0.04% on SPXD and SPXD is almost a £10bn fund). I don't expect liquidity to be an issue. Although during crashes all ETFs can drift a little from NAV. I am also unlikely to sell at a time of high market volatility.

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Re: Synthetic S&P 500 Trackers

#510389

Postby MDW1954 » June 28th, 2022, 7:40 pm

Yes, HL have SPXD (swaps/ synthetic) but also comparable S&P 500 ETFs such as SPX5 on a fully-replicated basis. OCF is higher (0.09% versus 0.05%) and the spread a little wider, but fully-replicated buys a lot of peace of mind.

MDW1954

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Re: Synthetic S&P 500 Trackers

#510463

Postby AWOL » June 28th, 2022, 11:30 pm

MDW1954 wrote:Yes, HL have SPXD (swaps/ synthetic) but also comparable S&P 500 ETFs such as SPX5 on a fully-replicated basis. OCF is higher (0.09% versus 0.05%) and the spread a little wider, but fully-replicated buys a lot of peace of mind.

MDW1954


....At the cost of US withholding tax which is the annoyance that is tempting me into the synthetic space. That's equivalent to 0.3% higher costs.

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Re: Synthetic S&P 500 Trackers

#510523

Postby Lootman » June 29th, 2022, 9:11 am

AWOL wrote:
MDW1954 wrote:Yes, HL have SPXD (swaps/ synthetic) but also comparable S&P 500 ETFs such as SPX5 on a fully-replicated basis. OCF is higher (0.09% versus 0.05%) and the spread a little wider, but fully-replicated buys a lot of peace of mind.

At the cost of US withholding tax which is the annoyance that is tempting me into the synthetic space. That's equivalent to 0.3% higher costs.

Where do you get that 0.3% higher costs from? The dividend yield on the S&P 500 is about 1.5%. If you lose 15% of that due to withholding then I make that an annual cost of 0.22%, or $22 for each $1,000 invested.

I am also not clear how you think that an index fund that is synthetic avoids that. Its return will still mirror the underlying shares, along with their dividends.

What you could really do with is some form of synthetic that doesn't pay out any distributions, but rather retains their value within the fund and rolls them up. Such rollup funds do exist offshore but they are generally not recognised as reporting funds in the UK, meaning that you pay income tax on the eventual profit. And they will probably cost more in annual charges than you would save in tax withholding.

Maybe Berkshire Hathaway shares are your solution. Has not paid a dividend for decades and is broadly invested across the US.

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Re: Synthetic S&P 500 Trackers

#510529

Postby TedSwippet » June 29th, 2022, 9:24 am

Lootman wrote:I am also not clear how you think that an index fund that is synthetic avoids that. Its return will still mirror the underlying shares, along with their dividends.

Lyxor published a paper a while back outlining how a synthetic S&P 500 ETF (specifically, their ETF -- after all this is marketing!) should outperform an equivalent physical replication fund:

An S&P 500 ETF like no other - Lyxoretf
This means that synthetic ETFs domiciled outside the US tracking qualified indices can receive dividends gross rather than net of the 30% WHT (or lower treaty rate) after costs.

As a result, synthetic S&P 500 ETFs domiciled outside the US such as ours can offer outperformance of up to ~30 basis points compared to physical Irish domiciled ETFs.

I'm too lazy to look at this ETF's performance charts and compare with physical S&P 500 ETFs to see if this is borne out in practice, or not. I do however think that their claim of "up to ~30 basis points" seems overstated. A physical Irish domiciled ETF could use the US/Ireland treaty for a 15% US withholding tax, so 15 basis points differential looks to be closer to the mark for most.

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Re: Synthetic S&P 500 Trackers

#510556

Postby AWOL » June 29th, 2022, 10:05 am

Between favourable tax status, lower fees and lower tracking error synthetic ETFs have done very well. Look at the screener here for example https://www.justetf.com/uk/how-to/sp-500-etfs.html

Regarding the saving from avoiding withholding tax, then this depends on the yield that varies with time and we are closer to all time lows for yield than the average. https://www.multpl.com/s-p-500-dividend-yield

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Re: Synthetic S&P 500 Trackers

#510973

Postby hiriskpaul » June 30th, 2022, 7:29 pm

I have been watching I500 for a while. what piqued my interest was not just the lack of withholding tax, but the complete lack of income! I believe the excess reportable income for the ETF should be zero, which would mean you could hold I500 outside a tax shelter and potentially save on both WHT and income tax on the ERI. So far they have only produced an excess reportable income report for the period from 24 September 2020 (launch date) to 31 March 2021 and this is indeed zero. I am waiting for the next announcement of the ERI to see what that says. Not sure when it comes out, but must be within the next few months.

I500 has outperformed the physically replicated iShares CSPX by 0.24% over the last year and they have identical TERs of 0.07%.

If I am right, I500 would provide an opportunity to invest in the S&P 500 outside a tax shelter without paying WHT or having to worry about income tax. Just buy and let it roll up. CGT would of course still be applicable on disposals, but that is manageable and rates are lower than income tax.

Edit: In addition, I500 is priced in pounds, so no FX costs to buy and as it does not pay dividends, no dividend FX conversion costs!

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Re: Synthetic S&P 500 Trackers

#511387

Postby AWOL » July 2nd, 2022, 5:11 pm

I had seen a little coverage of this favourable tax status but wasn't sure it was definitely policy. Does iShares state it clearly themselves? To be honest this is my dream scenario as i intend to take my pension lump sums and invest them in an S&P tracker and they will exceed the ISA allowance so will largely be unprotected.

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Re: Synthetic S&P 500 Trackers

#511421

Postby hiriskpaul » July 2nd, 2022, 8:41 pm

AWOL wrote:I had seen a little coverage of this favourable tax status but wasn't sure it was definitely policy. Does iShares state it clearly themselves? To be honest this is my dream scenario as i intend to take my pension lump sums and invest them in an S&P tracker and they will exceed the ISA allowance so will largely be unprotected.

This article seems to confirm it

https://www.etfstream.com/news/blackroc ... p-500-etf/

It is not mentioned in the iShares documentation as far as I can tell though. Perhaps it is not something they wish to publicise too widely.

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Re: Synthetic S&P 500 Trackers

#511443

Postby AWOL » July 3rd, 2022, 7:57 am

hiriskpaul wrote:
AWOL wrote:I had seen a little coverage of this favourable tax status but wasn't sure it was definitely policy. Does iShares state it clearly themselves? To be honest this is my dream scenario as i intend to take my pension lump sums and invest them in an S&P tracker and they will exceed the ISA allowance so will largely be unprotected.

This article seems to confirm it

https://www.etfstream.com/news/blackroc ... p-500-etf/

It is not mentioned in the iShares documentation as far as I can tell though. Perhaps it is not something they wish to publicise too widely.


I see mention of the withholding tax position but not the income tax avoidance. Am i missing something?

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Re: Synthetic S&P 500 Trackers

#511465

Postby hiriskpaul » July 3rd, 2022, 9:26 am

AWOL wrote:
hiriskpaul wrote:
AWOL wrote:I had seen a little coverage of this favourable tax status but wasn't sure it was definitely policy. Does iShares state it clearly themselves? To be honest this is my dream scenario as i intend to take my pension lump sums and invest them in an S&P tracker and they will exceed the ISA allowance so will largely be unprotected.

This article seems to confirm it

https://www.etfstream.com/news/blackroc ... p-500-etf/

It is not mentioned in the iShares documentation as far as I can tell though. Perhaps it is not something they wish to publicise too widely.


I see mention of the withholding tax position but not the income tax avoidance. Am i missing something?

The article says that the shares held, the return of which is swapped for the return of the S&P 500, are shares that do not pay dividends.

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Re: Synthetic S&P 500 Trackers

#511536

Postby AWOL » July 3rd, 2022, 3:16 pm

Thanks. I missed that. My reading comprehending is poor when on my phone. This looks like the ideal solution to a problem that I have been mulling over for a while. To some, it won't be worth the risks but I think the risks are no bigger than we accept elsewhere without worrying.

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Re: Synthetic S&P 500 Trackers

#516071

Postby 1nvest » July 20th, 2022, 6:59 pm

Be mindful that the likes of swaps can also include taxation elements, such as US 20% dividend taxation. Typically they don't swap gross - but net values. Similar for Futures. So whilst you might think you're achieving tax efficiencies, more likely you wont be.

For me the appropriate choice is for 50/50 MKL/BRK combo. Neither pay dividends and are somewhat Investment Trust/Conglomerates (widely/broadly diversified). But with that comes tracking error. Over the last decade or so MKL/BRK has lagged the S&P500, but in other cases outperformed it.

An added benefit is there are no fund fees either. The predominant risk however is that of Estate Tax (death duties), if you die when holding north of $60K of US assets your estate falls due for US estate taxation. Under US/UK tax treaty however UK citizens get the same generous $11M exemption as US citizens. HOWEVER your heirs have to fill out the correct forms in the correct manner within the correct timescales. Worth having a expert do that for the family as a grand or so/whatever fees could prove to be money well spent.

PS I've used 60K and 11M figures above as guides only, the actual amounts are somewhere thereabouts, too-lazy/time-pressured to look them up at present.

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Re: Synthetic S&P 500 Trackers

#517564

Postby hiriskpaul » July 27th, 2022, 10:13 am

1nvest wrote:Be mindful that the likes of swaps can also include taxation elements, such as US 20% dividend taxation. Typically they don't swap gross - but net values. Similar for Futures. So whilst you might think you're achieving tax efficiencies, more likely you wont be.

For me the appropriate choice is for 50/50 MKL/BRK combo. Neither pay dividends and are somewhat Investment Trust/Conglomerates (widely/broadly diversified). But with that comes tracking error. Over the last decade or so MKL/BRK has lagged the S&P500, but in other cases outperformed it.

An added benefit is there are no fund fees either. The predominant risk however is that of Estate Tax (death duties), if you die when holding north of $60K of US assets your estate falls due for US estate taxation. Under US/UK tax treaty however UK citizens get the same generous $11M exemption as US citizens. HOWEVER your heirs have to fill out the correct forms in the correct manner within the correct timescales. Worth having a expert do that for the family as a grand or so/whatever fees could prove to be money well spent.

PS I've used 60K and 11M figures above as guides only, the actual amounts are somewhere thereabouts, too-lazy/time-pressured to look them up at present.

Estates are only subject to US tax if they directly hold US property. Holding US shares via an Irish domiciled ETF insulates you from that complexity. Similarly, holding ITs and funds that contain US securities are fine, provided they are not US listed.

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Re: Synthetic S&P 500 Trackers

#517707

Postby 1nvest » July 27th, 2022, 5:22 pm

hiriskpaul wrote:
1nvest wrote:Be mindful that the likes of swaps can also include taxation elements, such as US 20% dividend taxation. Typically they don't swap gross - but net values. Similar for Futures. So whilst you might think you're achieving tax efficiencies, more likely you wont be.

For me the appropriate choice is for 50/50 MKL/BRK combo. Neither pay dividends and are somewhat Investment Trust/Conglomerates (widely/broadly diversified). But with that comes tracking error. Over the last decade or so MKL/BRK has lagged the S&P500, but in other cases outperformed it.

An added benefit is there are no fund fees either. The predominant risk however is that of Estate Tax (death duties), if you die when holding north of $60K of US assets your estate falls due for US estate taxation. Under US/UK tax treaty however UK citizens get the same generous $11M exemption as US citizens. HOWEVER your heirs have to fill out the correct forms in the correct manner within the correct timescales. Worth having a expert do that for the family as a grand or so/whatever fees could prove to be money well spent.

PS I've used 60K and 11M figures above as guides only, the actual amounts are somewhere thereabouts, too-lazy/time-pressured to look them up at present.

Estates are only subject to US tax if they directly hold US property. Holding US shares via an Irish domiciled ETF insulates you from that complexity. Similarly, holding ITs and funds that contain US securities are fine, provided they are not US listed.

Buying US listed shares directly from/in the US also count - more than $60K value and your heirs have to file US estate tax forms in order to get funds released.

Many US stock tracking funds match their US index, but measure relative to net total return i.e. after subtraction of standard 30% US dividend withholding taxes. Whilst that's reduced to 15% under UK (and Irish) US tax treaty, also factor in fund fees/costs and you pretty much end up with a relatively close tracking of that net total return index value. In a low yield era, 30% x 2% dividend = 0.6% lag of the gross total return as its benchmark, actual withholding tax 15% x 2% dividend = 0.3%, add on 0.1% fund management fees = 0.4% and yippee the fund is 'seen' to slightly outperform its 'total return' benchmark (but where additional costs are spent from dividends and the fund more aligns to its benchmark in practice). And that's in a low dividend yield era, if as might occur yields return back to 4% type longer term historic averages then investors might see 1%/year type lag/drag.

If you side step the withholding taxes and fees that's a potential 1% relative premium. But entails holding US stocks directly and as such exposes you to US estate tax risk - but equally where US/UK treaty is generous - such that UK investors have the same $11M (or whatever the actual figure) exemptions as US citizens.

Neither MKL nor BRK involve any fund managers fees and neither pay dividends so no withholding taxes either.

There's also a element of risk with Irish (EU) domiciled ETF's now that the UK has left the EU. At any time in the next 10, 20, whatever years rules might be changed to perhaps impose 75% withholding taxes, as France has applied in the past against 'unfriendly' nations. A possible trap whereby if you remain you're punished, or if you sell to escape that trap that might involve a large capital gain taxation event.

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Re: Synthetic S&P 500 Trackers

#517750

Postby TedSwippet » July 27th, 2022, 8:31 pm

1nvest wrote:There's also a element of risk with Irish (EU) domiciled ETF's now that the UK has left the EU. At any time in the next 10, 20, whatever years rules might be changed to perhaps impose 75% withholding taxes, ...

I'm generally as paranoid about the political risks of investing outside one's home country as it is possible to be, but the suggestion of 75% tax withholding on Ireland domiciled UCITS funds looks like tinfoil hat territory to me.

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Re: Synthetic S&P 500 Trackers

#517754

Postby 1nvest » July 27th, 2022, 8:47 pm

TedSwippet wrote:
1nvest wrote:There's also a element of risk with Irish (EU) domiciled ETF's now that the UK has left the EU. At any time in the next 10, 20, whatever years rules might be changed to perhaps impose 75% withholding taxes, ...

I'm generally as paranoid about the political risks of investing outside one's home country as it is possible to be, but the suggestion of 75% tax withholding on Ireland domiciled UCITS funds looks like tinfoil hat territory to me.

Scenario, UK/EU enter a trade war due to GFA issues, and with a prize of capturing financials that otherwise might have based in London as part of that opt to apply high dividend withholding taxes against dividends paid to UK residents/investors. But yes 75% would be excessively extreme, but maybe 50% !!

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Re: Synthetic S&P 500 Trackers

#517762

Postby hiriskpaul » July 27th, 2022, 9:50 pm

1nvest wrote:
TedSwippet wrote:
1nvest wrote:There's also a element of risk with Irish (EU) domiciled ETF's now that the UK has left the EU. At any time in the next 10, 20, whatever years rules might be changed to perhaps impose 75% withholding taxes, ...

I'm generally as paranoid about the political risks of investing outside one's home country as it is possible to be, but the suggestion of 75% tax withholding on Ireland domiciled UCITS funds looks like tinfoil hat territory to me.

Scenario, UK/EU enter a trade war due to GFA issues, and with a prize of capturing financials that otherwise might have based in London as part of that opt to apply high dividend withholding taxes against dividends paid to UK residents/investors. But yes 75% would be excessively extreme, but maybe 50% !!

That would put Ireland in breach of the Eire/UK tax treaty, which has nothing to do with EU membership or the GFA. Blackrock, Vanguard, etc. would immediately redomicile funds into the UK if they ever tried to pull a stunt like that and they would never go back. Undermining their own financial services sector would be immensely harmful to Ireland. Not going to happen.


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