Know the difference between a CDI, CREST, and a SNAFU? Ever paid much attention to how your investment platform settles your buys and sells?

Or are you a fan of keeping investing simple, and hence you sensibly avoid all that wonky jargon?

Good for you – but occasionally investing will throw you a curve ball.

I spy a CDI

Monevator reader Jamie wrote to ask us if he’s liable for additional charges on Irish domiciled ETFs, post-Brexit.

The question arose because of an email Jamie received from his platform, EQi. The email said that Irish securities have been reclassified as international equities in the UK, as of 15 March 2021. This meant they were now subject to foreign transaction charges.

My platforms did not send me a similar notice. But EQi is right that the status of Irish securities has changed.

And that includes many of the most popular ETFs used by UK investors, which happen to be domiciled in Ireland.

The gift that keeps on giving

Prior to Brexit, most Irish securities traded via CREST, the UK’s electronic trade settlement system.

However, the European Commission decided against allowing this system to continue operating in the EU.

ETF providers have therefore migrated their Irish funds to the International Central Securities Depository (ICSD) system. This enables settlement across multiple European stock exchanges.

The upshot of all the regulatory hokey cokey?

A share in an Irish ETF that is traded on the London Stock Exchange is now issued to UK investors as a CDI (CREST Depository Interest).

So, does this mean that investing in an Irish ETF – in CDI form – will now also involve paying off a dodgy courier demanding random import duties?

What is a CDI?

A CDI is a financial instrument that represents a holding of a single share held in a foreign central securities depository (CSD).

CREST is the UK’s central securities depository. It was also Ireland’s, before Brexit.

CDIs were created because non-UK shares cannot be held directly in CREST.

If you trade overseas shares then you’re likely already doing so through the use of CDIs.

When you buy a share on a foreign stock exchange, your share will be held in the name of CREST – or its intermediary – in that country’s central securities depository.

To ensure you don’t feel ripped off, CREST issues a CDI. This CDI acts as your UK proxy for the foreign share.

CDIs are generally treated the same as the underlying shares:

• The share price is the same.
• The dividends are the same and paid according to the same timeline.
• They may be liable for withholding taxes.
• They’re not subject to UK stamp duty ((CDIs representing shares in UK companies will be liable for stamp duty.)). However you may pay any equivalent levy imposed by the underlying share’s home market.
• The rules and protections that govern the underlying ETFs still apply.

The main differences I’ve been able to uncover is that the bid-offer spread may vary, and your broker may charge additional international fees.

Or they may not.

In reality…

I think the reason my platforms did not notify me of any change is because they are not layering on international fees now that my Irish-domiciled ETFs no longer settle through CREST.

I checked a range of ETFs through AJ Bell. The charges are the same as they were before the final 29 March deadline for Irish securities to switch over.

The spreads are a few pence for my emerging markets and bond ETFs. They are just fractions of a penny for my developed world ETFs.

Foreign exchange fees were always previously charged whenever my dividends had to be converted into sterling. I’m not paying new fees there.

As far as I can tell the switchover of Irish ETFs to CDIs in the UK has made no difference to me whatsoever.

Please let us know if your experience differs.

It seems that some iShares, SPDR, and Vanguard ETFs made this switch months – even years – ago.

We haven’t been alerted to any funny business by Monevator readers. There hasn’t been much unrest about it in the febrile financial forums either.

I can’t help but wonder that Luxembourg-domiciled ETFs must also have been settled in the UK as CDIs, pre-Brexit?

This recent kerfuffle occurred because Ireland – unlike other European countries – previously used the UK’s central securities depository – CREST.

So unsettling though Jamie’s email was, it looks like it doesn’t make any material difference to UK investors in Irish-domiciled ETFs.

Just so long as your platform doesn’t treat the change as a nice little earner.

Take it steady,

The Accumulator

What caught my eye this week.

I got the call to be vaccinated against Covid this week. I admit that being in the midst of reading about super-rare blood clots linked to certain Covid vaccines at the exact time didn’t fill me with joy.

But as Tim Harford says in the Financial Times:

An educated guess, based on UK data, is that being vaccinated with the AstraZeneca jab carries a one-off risk of death of one in a million — not much higher than the risk of dying in an accident while travelling to a vaccination clinic.

Compared to all manner of sacrifices and gambles we take every day – for ourselves, and for the people we care for – these are tiny odds.

And in particular, as someone who spent the first few months of this pandemic wondering whether perhaps a persistent lockdown for all was the wrong strategy, given the low risk for most (a position regulars will recall I’d abandoned by the end of summer, in the face of the evidence) it would be hypocritical indeed to try to duck a one-in-a-million dice roll.

Not least on a personal selfish basis.

Even if you believe that your personal odds of a truly bad outcome from Covid are very low, as I do, I would definitely not claim mine are anything like as low as one in a million.

Or even one in 250,000 for that matter (the rough estimate of suffering a non-fatal clot).

Or even one in 50,000!

But that’s the human brain for you.

Odds that you can persuade yourself look long in the abstract can make you queasy when you will take even more unlikely ones in the next 15 minutes.

Vacillated or vaccinated?

I’ve included lots of links below for anyone who wants to know more on this blood clot issue.

All my friends have been thrilled when they’ve got the call to be vaccinated. Now my generation is on-deck, my social media is ablaze with vaccinations. My co-blogger The Accumulator booked his shot the moment he got the link. Most readers will be equally keen to get vaccinated ASAP.

A few readers are borderline anti-vaxxers, though they may dispute it. I appreciate I’ve opened the subject here. But that’s because I want to do my bit to make the case for taking the vaccine, even if you’re of a nervous disposition, as a coda to our discussions on Covid over the past 14 months.

In any event, all comments I personally consider unscientific or conspiracy-based will be deleted at my whim. (Hopefully this won’t happen. I very rarely delete comments.)

Ready or not

Ultimately it’s still a personal choice in the UK. For most adults, the best decision clearly looks to get vaccinated.

For ourselves and the wider good.

Let’s not forget that those arguments some of us made about deaths due to NHS disruption and so forth from a hard lockdown hold equally true here.

If the entire UK population of roughly 67 million could get vaccinated tomorrow and a worst-case 67 people died, who could argue more lives wouldn’t be saved overall by the health service, society, and the economy (and tax take) getting back to normal…

Will having the shot involve a dice roll?

Yes, like everything else in life.

But as a friend of mine quipped to me as my own jab approached, you’re rolling a dice with 1e6 sides!

As for the usual side effects, I’ve been lucky. Just feel a bit congested.

Hopefully many millions more 30-minute sessions like mine will soon put this thing behind us.

Have a great weekend!

[continue reading…]

I am super happy to welcome back Lars Kroijer for another investing Q&A. This is a collaboration between Monevator and Lars’ own YouTube channel.

All the questions below come from Monevator readers. As before, Lars’ answers in both video and edited transcripts.

Note: embedded videos are not always displayed by email browsers. If you’re a Monevator email subscriber and you can’t see three videos below, please head to our website to view this Q&A with Lars Kroijer.

What’s the case against dividend stocks?

We start this time with a question from Ray. He is in the de-accumulation phase, but he’s still looking for a return on his investments.

Ray notes that Lars tends to recommend global equity market trackers. However, Ray continues, “this year, the ACWI – the All Country World Index – is only paying a 1.7% dividend, whereas my dividend-focused ETFs seem to be doing better than that. So is my strategy wrong?”

Lars replies:

So here we’re in the world of equities. I have explained elsewhere why most people should not have just equities in their portfolio. It is typically far too risky. Please see my other work for more on that.

It’s also worth noting that I argue you can’t outperform the markets. You should simply buy equities in proportion to their market value and diversify across the total world market as much as you possibly can, and as cheaply as you can. We do that is because we don’t think we can allocate value between equities in a superior way to the market. We accept that we cannot beat the market.

On to this question about dividends.

The first thing to ask: is there any reason to think that dividend paying stocks overall will outperform non-dividend paying stocks? And the answer to that is, no – unless you think you can beat the markets.

With dividend-paying stocks, you get a change in the share price – capital appreciation – plus the dividend. Whereas with non-dividend paying stocks, you just get that change in the share price.

Now I think what Ray is alluding to – and practically speaking, I can see an argument for – is automatically receiving dividends into your bank account. You need the cash, perhaps for your living expenses. If you have non-dividend paying stocks, you have to sell securities to realize your capital to get that cash. That can be a headache for some people.

I think the overriding issue is one of tax.

Suppose we have two groups of stocks. One pays a 5% annual dividend and the other does not pay a dividend.

Let us say the first group is flat for the year. But you received your 5% dividend, so your $100 became $100 plus $5 as a dividend.

With the second group you do not receive any dividend. However those shares went up by $5. So they are now worth $105.

This could be a similar group of stocks. It could even be index trackers with different payout policies, which may be what Ray is alluding to.

Anyway, with the second group, to obtain the cash you would have gotten from your dividends with the first group, you can sell 5% of your portfolio. You should – ignoring tax – be equally well-off.

For most people, in one case you would be paying a dividend tax and in the other a capital gains tax. That choice is what should drive your decision. It’s not that we think we can predict which group of stocks will do better. It’s more that your individual tax situation should drive it.

Also note some trackers pay out the dividends they receive from the underlying companies. Others reinvest it. Again, which type you own should depend on your current and expected future tax situation.

That should be the driver, not the dividend policies of the underlying businesses.

Beyond a global tracker for equities

Next up is ‘MBA’, who asks: “Does your case for using a global tracker fund mean one should not invest in a global smaller company tracker? At the moment, my split is 60% global all caps, 20% global smaller companies, and 20% emerging markets.”

Over to Lars:

Let me start by emphasizing that I believe you should really try – with the equity portion of your portfolio – to own equities in proportion to their market values.

Of course most people should not only own equities. There are other videos I’ve done on how you should think about your split between different asset classes. Equities-only would be too risky for most people.

Ideally, you should invest in equities according to their market value. You are essentially saying each dollar invested in equities is equally clever and well-informed. You don’t think you can do better by allocating the proportions of your stocks in a different way from what the market has already done.

You say this because you accept you cannot outperform the markets. You’re simply trying to capture the global equity risk premium. What this is is anyone’s guess! But historically, equities have outperformed the risk-free rate by about 4-5% above inflation.

I am saying you should invest in all equities to capture this premium.

But in reality, as MBA suggests, a lot of the indices do not really include small caps. Small caps may be too expensive or illiquid to trade. It’s therefore hard to represent them perfectly, all over the world. So very often they’re excluded – certainly in the larger indices.

Likewise, a lot of indices have a heavier weighting to the US market compared to its share of GDP, or to global equity values. There are various reasons for this. One is there is a disproportionate number of huge global companies quoted in the US. Think Google, Facebook, Apple, and so on. These are all large global firms, with a lot of business outside the US. The stocks are bought on the US market. But that does not mean you’re only exposed to the US economy with them.

In any case I don’t really have a problem as to what MBA suggests with people that say “I kind of want to correct this lack of exposure to small caps” or “I kind of want to get a little bit away from what some perceive as an overexposure to the US stock markets”. You might do that by buying small cap index funds. Just be sure you do it in a globally diversified way.

Make sure you do not end up with a portfolio where you essentially become a collector of indices. You can have so many indices tracked that you don’t quite know what is there or why.

A lot of global indices are highly-correlated. I think you get 95% of the way there by owning a global tracker.

Holding cash instead of government bonds

Our last question comes from ‘Haphazard’, who asks, “Do you still believe the lowest-risk part of a portfolio should be in a government bond fund? Even with today’s very low negative yields – as opposed to cash, for example?”

Lars replies:

First, a reminder. I believe that for a large majority of investors, you can create a very robust portfolio with two products. You select the lowest risk government bond in your currency and at the appropriate maturity, and you combine that with a global equity index tracker. You choose the proportion to suit your individual risk preferences.

Check out my previous video series on Monevator for more on that.

Coming back to Haphazard’s question, I don’t have a problem with cash. I would just encourage you to think of the risk of the bank where you have your cash, versus the risk of a local government bond.

For most developed economies, there is a deposit insurance. The government guarantees deposits and banks up to a certain amount.

That means for up to that amount you’re effectively taking government risk.

As a side note, this means if you have your money with one of the larger banks in your country, there is a high correlation between the failure of that bank and the failure of your government. I know that in a lot of the economies around the world that may seem remote in early 2021, but it is something to think about.

I would also say be careful about going yield hunting among other country’s government bonds. You would be taking FX risk in a lot of cases. Also, if you’re getting a higher yield you’ll typically be taking some credit risk. The higher yield alone does not tell the whole story.

Most people would intuitively understand the very high interest rates you’re getting from governments like that of Venezuela do not make much sense. You’re taking massive FX risk and credit risk. People would therefore stay away. But even in less extreme samples, you’re taking FX risk and credit risk if you are getting a higher yield.

Coming back to cash – and maybe cash alternatives – with your local bank. As long as it is within the insurance limits, then absolutely take it if you’re getting higher yields.

However if you’re buying your local bank’s fixed income products and they’re giving you a far higher return than your local government bond – and you aren’t within the deposit insurance – I’d encourage you to understand what kind of risk you are taking.

Are you well-equipped to take that risk?

For example, you might make higher returns with corporate bonds than your government’s bonds. But you’re also taking a different and in some cases a far higher risk that you may not be very well-equipped to take.

I also worry a bit when people say interest rates are so low they cannot possibly go any lower. Predicting interest rates is like predicting stock markets. It’s very hard for individual investors to do better than the market.

I’d encourage you to really think about what it is you believe you know that enables you to do that.

If you feel the minimal-risk asset’s interest rate does not give you enough return in your simple two-product portfolio – and you’re willing to take more risk – I’d say maybe take that risk in the equity markets. At least that keeps things simple.

The lowest risk part of your portfolio is not a return generator. It is the part where you say you’re not going to lose this money, come what may. So perhaps try not to be greedy!

Until next time

Please do follow-up Lars’ answers in the comments below. You can also ask us questions for next time, although we’ll only be able to pick three of them.

Watch more videos in this series. You can also check out Lars’ previous Monevator pieces and his book, Investing Demystified.