UCITS vs U.S. ETFs – Pros and Cons for Non-US Investors

UCITS ETFs: A Strategic Move for Latin America, Asia & the Middle East

ETF Domicile is not very glamour. And something that most new investors won’t pay attention to. While fees and index tracking frequently steal the spotlight, the domicile’s pivotal role in portfolio performance cannot be overstated.

Some of our readers from Latin America, Asia and the Middle East know how to optimise their tax bill.

But here is what most investors ignore, and may pay a heavy price for it.

KEY TAKEAWAYS

  • Key Choice: The domicile of an ETF is crucial, impacting tax obligations and investment returns, with UCITS ETFs offering a strategic alternative for non-U.S. investors.
  • US ETFs Have Better Liquidity And Lower Costs: While US ETFs boast higher liquidity and lower costs due to the U.S. market’s size, UCITS ETFs may face more liquidity challenges due to European market fragmentation but are catching up, providing global accessibility with slightly higher expense ratios.
  • Not all investors can invest through U.S. ETFs – Most European Investors can’t access US ETFs unless they apply to be elective professional clients with their Brokers.
  • Tax Benefits For Non-U.S. Investors Outweigh Higher Costs: UCITS ETFs often offer more favourable tax treatments, lower withholding taxes on dividends, no U.S. estate tax, and simplified tax reporting, in most cases outweighing the cost considerations.
  • Latin American, Asian or Middle Eastern Investors Can Access Them Locally – UCITS ETFs are listed on Stock Exchanges in Singapore, South Africa, Israel, Saudi Arabia, Brazil, Chile, Mexico or Peru, but they are also often accessible through European Stock Exchanges.
Here is the full analysis

What are Main two ETF types?

U.S. and UCITS ETFs represent 90% of The Global ETF Market

US ETFs and UCITS ETFs present distinct features, catering to diverse investor needs globally.

  • U.S. ETFs – Governed by the SEC, they operate primarily within U.S. markets under the Investment Company Act of 1940 and Securities Act of 1933, offering favorable taxation for U.S. investors. These funds typically distribute income and have greater access to leverage, with fewer restrictions on securities lending.
  • UCITS ETFs – regulated by ESMA and compliant with the UCITS Directive (Undertakings in Collective Investments and Transferable Securities), focus on global markets with a significant presence in Europe, also providing tax efficiency for other non-U.S. investors. They have stricter rules regarding securities lending and leverage, and they can either distribute or reinvest income. UCITS ETFs are domiciled mainly in Luxembourg or Ireland, offering a broader global accessibility with currency hedging options and compliance with stringent investor protection and risk diversification standards.

US vs UCITS ETFs

CharacteristicUS ETFsUCITS ETFs
Regulatory BodyU.S. Securities and Exchange Commission (SEC)European Securities and Markets Authority (ESMA)
Primary LegislationInvestment Company Act of 1940 & Securities Act of 1933UCITS Directive
Geographical FocusPrimarily U.S. marketsGlobal markets with a strong presence in European markets
Investor ProtectionStrong, with emphasis on disclosure and transparencyStrong, with comprehensive rules on diversification, risk, and investor protection
TaxationFavorable for U.S. investorsOften more tax-efficient for non-U.S. investors
Distribution PolicyGenerally distribute incomeCan either distribute or reinvest income
Securities LendingPermitted with fewer restrictionsPermitted but with stricter collateral and transparency requirements
Fund DomicileUnited StatesTypically Luxembourg or Ireland
Access to InvestorsGlobal, but mainly targeted at U.S. investorsGlobally accessible, passportable within the EU
Currency Hedging OptionsAvailableWidely available with multiple currency share classes
Source: Bankeronwheels.com. As of September 2023.

Niche ETF Markets include Asia-Pacific, Latin America & South Africa

As of August 2023, just over 11% of all ETFs are not domiciled in Europe or the U.S. These include mainly Asia:
  • Japan – represents just below 5% of all ETFs
  • Asia-Pacific ex-Japan – representing just over 6%, including markets like Australia
Some countries in Latin America, and South-Africa have tiny market shares (<1%) but investors in those countries usually choose U.S. or UCITS ETFs.

Global ETF Market by Domicile

Source: Refinitiv. As of August 2023.

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Who can ACCESS U.S. AND UCITS etfs?

U.S. ETFs

Investing in U.S. ETFs is not limited to U.S. citizens

There are no specific laws prohibiting non-U.S. citizens from investing. 

Both the Securities and Exchange Commission and the U.S. government encourage foreign investments in U.S. equities and debt markets to fund the U.S. capital markets and economy.

But As European You Will Likely Need A €500k Portfolio

However, the situation is different for investors in Europe due to regulatory changes. Since 2018, individual investors in the EU have been restricted from investing in U.S. ETFs. 

This is due to regulations that require ‘Key Information Documents’ (KIDs) to help them better understand the products they are buying. U.S.-registered ETFs do not contain this document, which led to the restriction on trading U.S.-registered ETFs in Europe. 

As European, you can get around this restriction in becoming an elective professional client. There are certain criteria to fulfil, but in practice you must often have €500,000 in your financial portfolio.  Alternatively, certain U.S. Brokers may offer access to them.

UCITS ETFs

Outside the U.S., any Global Investor Can Access UCITS ETFs

Investors in Asia, South America, or the Middle East can invest through European products. 

UCITS ETFs are listed, amongst others, on Stock Exchanges in Singapore, South Africa, Israel, Saudi Arabia, Brazil, Chile, Mexico or Peru. But non-US Investors can also often access them directly through European Stock Exchanges.

For example, in South Africa investors can access iShares funds through 1NVEST feeder funds.

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Outside of taxes, U.S. ETFs have more advantages

How do ETF Markets compare?

US ETFs typically exhibit higher liquidity and larger average daily trading volumes, primarily due to the substantial size and depth of the U.S. financial markets.  The competitive landscape in the U.S., with numerous market makers and a broad range of sectors and strategies covered, further enhances liquidity and lowers expense ratios through economies of scale.

Conversely, UCITS ETFs, while diverse, face challenges in liquidity and trading volumes due to market fragmentation in Europe. This fragmentation stems from UCITS ETFs being listed on multiple exchanges across various countries, leading to divided market participation and visibility.

Costs, liquidity and lack of fragmentation

CharacteristicUS ETFsUCITS ETFs
LiquidityOften higher due to the size of the U.S. market and the presence of many large, established ETFsLiquidity can be lower compared to their US counterparts, though this varies between funds
Average Daily Trading VolumeGenerally higher, leading to tighter bid-ask spreadsTypically lower than US ETFs, which may result in wider bid-ask spreads
Market ParticipationHigh participation from both institutional and retail investorsInstitutional investors dominate, with growing participation from retail investors
Exchange PresenceTraded on few major U.S. exchanges with high visibility and accessibilityListed on multiple exchanges across Europe and internationally, with varying levels of visibility and accessibility
Access to InvestorsGlobal, but mainly targeted at U.S. investorsGlobally accessible, passportable within the EU
Expense RatiosTypically lower due to competition and economies of scale in the U.S. marketGenerally marginally higher as compared to US ETFs due to various factors including tax treatments and operational costs associated with cross-border transactions
Source: Bankeronwheels.com. As of September 2023.

U.S. Funds have Lower costs

Although they offer international accessibility, the expense ratios in UCITS ETFs are generally marginally higher. This can be attributed to operational complexities and costs arising from the need to navigate through the diverse and fragmented European financial markets, as well as the taxation structures inherent to each jurisdiction.

For the most liquid asset classes (S&P 500) differences are minimal while Bonds may have larger discrepancies (difference of 0.22%).

Fund Total Expense ratio comparison

ETF TickersAsset ClassCoverageUS TERUCITS TER
VT/VWCEEquitiesGlobal0.05%0.22%
VOO/VUSAEquitiesS&P 5000.03%0.07%
BND/SUAGBondsUS Bonds0.03%0.25%
VASGX/V80AFund of FundsEquities & Bonds0.14%0.25%
Source: Bankeronwheels.com. As of September 2023. Funds of Funds are a comparison of US domiciled Vanguard Lifestrategy Funds and UCITS ETFs.

U.S. Funds have more product variety and Factor Investing issuers

The variety of products available in the U.S. financial markets is superior. The U.S. markets offer a broader selection of Exchange-Traded Funds (ETFs), including an extensive range of factor ETFs that are designed to capture specific risk factors or investment styles, such as value, size, volatility, momentum, and quality.

Niche issuers of factor ETFs in the United States include American Century Investments (Avantis), Dimensional Fund Advisors or Alpha Architect.

UCITS ETFs have stricter rules, although it's usually not problematic

In theory, UCITS ETFs have a number of other restrictions, including asset concentration or investment restrictions.

In practice, Europeans also have access to other funds:

  • ETC and ETN Funds – that invest in commodities or cryptocurrencies.
  • REITs that invest in Real Estate.
Concentration rules are usually not problematic for diversified, long-term investors.

UCITS Restrictions

Requirements/FeaturesUCITS FundsUS Funds (General Mutual Funds & ETFs)
Domicile & Management LocationMust be based in a tax-neutral European country.Typically based in the US. Offshore funds also exist but are less common.
Redemption OptionsOffer double redemption within a single month.Redemption policies vary; often daily redemption is available.
Asset Liquidity & Investment RestrictionsAt least 90% liquid assets; no exposure to short selling, real estate, or commodities.Varying levels of liquidity requirements; some funds might invest in illiquid assets, short sales, real estate, or commodities depending on their strategy.
Asset Concentration RulesNo asset more than 10%; holdings of more than 5% cannot in aggregate exceed 40%.Diversification rules vary; mutual funds often have different standards, and some ETFs might be highly concentrated.
Borrowing LimitsTemporary borrowing not allowed for investment purposes.Funds may engage in borrowing, with limits outlined in the 1940 Act and specific fund policies.
Investor Documentation & InformationKey Investor Information Document and prospectus must be provided.Funds must provide a prospectus and, for ETFs, additional information in the form of a Summary Prospectus or Statement of Additional Information.
Pricing Information DisclosureMust inform investors promptly of pricing changes related to transactions.Must disclose NAV daily, and ETFs usually have intraday indicative values available. Pricing transparency requirements for transactions vary.
Source: Bankeronwheels.com. As of September 2023.

TAXES - The crucial differentiator

Advantages of UCITS ETFs

UCITS ETFs Have a Unique Global Status

EU nations have streamlined fund regulation with UCITS, enabling a seamless cross-listing of funds and ETFs across member states. But UCITS isn’t just a European sensation—it’s a global trailblazer. 

UCITS has become a well-recognized regulation standard for mutual funds and ETFs, and some countries in South and Middle America, as well in Asia, allow UCITS funds to be cross listed and sold to local investors. 

There is no other regulatory framework competing with UCITS that allows funds to be distributed globally (other countries have only bilateral agreements).

Most Non-US Investors have tax advantages with UCITS ETFs

From a non-U.S. investor’s tax perspective, UCITS ETFs often present a more favourable tax environment compared to US ETFs. 

When you invest in US ETFs you may face:

  • Higher Withholding Taxes – US ETFs typically incur a 30% withholding tax on dividends, which can sometimes be reduced through tax treaties
  • Estate Taxes – US ETFs may also expose non-U.S. investors to U.S. estate taxes and potential capital gains taxes in the U.S.
  • Complex Tax Reporting – for US ETFs can also be complex for non-U.S. investors.

Conversely, UCITS ETFs usually enjoy:

  • Lower Withholding Taxes – on dividends due to favourable treaties with countries where they are commonly domiciled, like Ireland and Luxembourg. 
  • No Estate Taxes – They pose no U.S. estate tax exposures 
  • Simplified Tax Reporting – They offer simplified tax reporting.
  • Further Tax Optimisation – With the flexibility of choosing between distributing and accumulating share classes. This structure often results in efficient tax growth and potentially favourable capital gains tax treatment, depending on the investor’s country of residence. 

TAxes - Why it pays to invest through UCITS etfs

CharacteristicUS ETFsUCITS ETFs
Withholding Tax on DividendsOften subject to 30% withholding tax (though it might be reduced based on tax treaties)Lower withholding taxes; often 15% for many countries due to favourable tax treaties e.g. Ireland
Estate Tax ExposureNon-U.S. investors might be subject to U.S. estate taxesNo exposure to U.S. estate taxes
Tax Reporting ComplexityMay require complex tax reporting in investor's home countrySimplified tax reporting due to international standards accommodated by UCITS directive
Capital Gains TaxMay be subject to capital gains tax in the U.S., depends on the investor's tax status and residenceCapital gains tax treatment varies, typically levied in the investor's country of residence
Accumulation/DistributionGenerally do not offer accumulating share classes; dividends are usually distributedOffer both distributing and accumulating share classes, allowing for tax-efficient growth
Tax Treaty BenefitsLimited benefits for non-U.S. investors, depending on existing tax treatiesMultiple double taxation treaties due to the domiciles in Ireland and Luxembourg, often resulting in favorable tax outcomes for international investors
Source: Bankeronwheels.com. As of September 2023.

Advantages of U.S. ETFs

U.S. Investors have tax advantages with U.S. ETFs

Conversely, the main reason why U.S. Investors might prefer U.S. ETFs is to avoid local tax complications.

Investing in U.S. ETFs allows U.S. investors to avoid the complications and stringent reporting requirements associated with PFIC regulations. U.S.-based ETFs typically offer a more straightforward tax treatment, making them more attractive to U.S. investors.

U.S. ETFs are structured in a way that is compliant with U.S. tax laws, and the tax reporting is more straightforward. The dividends and capital gains from these ETFs are subject to U.S. tax laws, which investors and their tax advisors are usually more familiar with.

Certain European Investors may have tax advantages with U.S. ETFs

It is a rare situation. But there are certain European countries that have protection against US Estate taxes (please verify before investing) and allow investors to buy US ETFs, potentially offsetting withholding taxes against local dividend taxes.

For example, some investors in the UK (assuming you meet the €500k eligibility criterion) and Switzerland may fall into this category. We have a dedicated guide to reducing withholding taxes for Europeans Investors.

Overall impact - For Which Investors is UCITS more advantageous?

South America, Middle East and Asia - Investors Should consider UCITS ETFs

There are two cases when UCITS ETFs can be particularly useful:

  • For countries without an income tax agreement with the U.S.
  • For countries with an income tax agreement but with a weak Estate Tax protection.

For Countries without income tax agreement with the US

Additional 15% Dividend Withholding Taxes apply to all countries without a tax agreement with the US. 

According to KPMG, certain countries are particularly exposed to tax leakage, including:

  • Asia: Singapore, Malaysia or Vietnam.
  • Middle East: Oman, Qatar, Saudi Arabia or United Arab Emirates
  • South America: Most countries, including Argentina, Brazil and Chile.
  • Africa: Almost all countries.
  • Europe: Croatia, Liechtenstein, Macedonia, Malta, Monaco, Montenegro, Serbia.

For Countries With an income tax agreement with the US- Will You Hold More Than $60,000 In U.S. ETFs?

Even with an income tax treaty between the U.S. and another country, non-U.S. investors in U.S. ETFs might still navigate challenges like potential U.S. estate taxes.

US estate taxes begin at just $60,000 of US holding for non-resident aliens and apply at rates of 26-40% of assets above that level without a US estate tax treaty.

Only sixteen countries have estate tax treaties with the US: 

  • Asia – Japan, Australia.
  • Europe – Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Norway, Switzerland and the UK.
  • Africa – South Africa

However, not all of them are structured favourably. A poor US estate tax treaty does not increase the US estate tax exemption for non-resident aliens to more than the standard $60,000 amount. 

In contrast, investing in UCITS ETFs alleviates these concerns as they’re domiciled outside the U.S., often in jurisdictions like Ireland or Luxembourg, eliminating U.S. estate tax liabilities for foreign investors and, in certain cases, reducing administrative hassles related to U.S. tax documentation and reporting. 

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Conclusion

Consider your personal situation

In conclusion, while US ETFs generally offer superior liquidity and lower costs due to the vast size and depth of the U.S. financial markets, non-U.S. investors should closely consider UCITS ETFs due to significant tax advantages.  The tax benefits of UCITS ETFs, coupled with no U.S. estate tax exposure and simplified tax reporting processes, often outweigh the marginally higher expense ratios they might carry.

But, there could be exceptions. Understand your individual circumstances before buying ETFs.

With the continuous growth and development in the UCITS ETF market, the gap in liquidity and investment options compared to US ETFs is narrowing, making UCITS ETFs an increasingly attractive and competitive investment vehicle for international investors.

Thank you for reading.
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