AAXJ

Overview

iShares MSCI All Country Asia ex Japan ETF (AAXJ) tracks the MSCI AC Asia ex Japan index and holds its constituents directly, a physical replication managed by iShares. Dividends are paid out to holders rather than reinvested, so AAXJ suits investors seeking regular income. The fund is domiciled in US, which determines the withholding tax treatment applied to its dividends. Annual charges come to 0.70% of assets, and the fund holds 4.0B under management. Over five years the fund returned 4.2% a year on average, against 20.6% over three years. It is not eligible for the French PEA, but can be held in a securities account, a UK ISA or a German Depot. Its risk level is rated high. Launched on 2008-08-13, the fund is denominated in USD and has 18 years of track record. Because AAXJ distributes, every payment is taxable in the year it is received, against the dividend allowance in a general account, while it stays sheltered inside an ISA or a SIPP. Domicile in US sets the withholding the fund itself suffers on the dividends it receives, a cost absent from the stated fee but present in the return.

At 0.70%, this fund costs more than twice the median of its category (0.19%) and over 35.0 times the cheapest (0.02%). On £10,000 the gap to the median is worth about 510 over ten years, and that difference is certain in a way no performance gap is. A premium can be justified, by an index no competitor tracks, by a useful trading currency, or by size that guarantees liquidity; it is not justified by the brand. The question is therefore plain: what does this fund offer that the cheapest on the list does not?

Replication is physical: the fund actually holds the constituents of MSCI AC Asia ex Japan, which makes its contents verifiable line by line in the issuer's report. Two points deserve attention. Securities lending first, practised by most physical funds to reduce costs: it earns a few hundredths of a point and creates an exposure to the borrower, covered by collateral, with the annual report stating the proportion lent. Rebalancing second: every change in the index's composition forces the fund to buy and sell, and those internal costs are not in the 0.70% headline. That is why two funds at the same price do not track their index with the same fidelity.

The fund is domiciled in the United States, and for a European investor that is the point to settle before any other. A US fund is outside UCITS regulation: most European brokers cannot offer it to a retail client for want of a key information document, so access depends on the investor's status. Two tax consequences follow as well: dividends paid to a non-resident bear US withholding, reduced by treaty where a W-8BEN is in place, and US securities held directly fall within US estate tax above a threshold that is low for a non-resident. An Irish-domiciled equivalent avoids both questions.

Income is distributed: the fund pays out the dividends it receives, usually one to four times a year. For a holder living off the portfolio that is what is wanted, since the income arrives without selling. For someone still accumulating it is a tax disadvantage in a taxable account: each payment is taxed in the year received, so the amount reinvested is reduced before it starts working again. Reinvesting by hand also costs a dealing commission each time and often leaves cash idle for want of the price of a whole unit. An accumulating class on the same index, where one exists, settles the question.

With 4.0 billion in assets and 18 years of history, this fund has the size and the record that make closure unlikely and the spread narrow. Three checks remain, once a year, none of which depends on the market. The ongoing charge, which an issuer revises without notice and whose gap to a competitor can invert. The tracking difference, the only figure that says whether replication stays faithful. And the methodology of MSCI AC Asia ex Japan, which can change its selection or weighting rules without the fund's name moving, in which case what you hold has changed with nothing to announce it.

MSCI AC Asia ex Japan covers a single country, which concentrates three risks at once: its economy, its currency and its sector structure, since a national index reflects the country's industrial history rather than a chosen balance. A country position therefore makes sense to complete an already diversified portfolio, rarely to build one. The question to settle before buying is currency: a return published in one currency and real exposure to another diverge over several years, and a currency-hedged fund answers a different question, at the price of hedging costs that vary with the interest rate gap.

Over one year the fund shows 14.5% against 4.2% annualised over five years: the recent year sits well above the long average. A gap in that direction mainly counsels care about the entry point, since what has risen sharply lately costs more today than a year ago, and the long average is the figure that best describes what to expect.

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