XXSC

Overview

Xtrackers MSCI Europe Small Cap UCITS ETF 1C (XXSC) tracks the MSCI Europe Small Cap index and holds its constituents directly, a physical replication managed by Xtrackers. Dividends are reinvested inside the fund rather than paid out, so XXSC suits investors building a position over time. The fund is domiciled in LU, which determines the withholding tax treatment applied to its dividends. Annual charges come to 0.30% of assets, and the fund holds 3.7B under management. Over five years the fund returned 3.5% a year on average, against 16.8% 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 2008-01-30, the fund is denominated in EUR and has 18 years of track record. It is a UCITS fund, so it follows the European framework on diversification, liquidity and asset segregation. Because XXSC accumulates, nothing is taxed while the shares are held: the charge falls on disposal, against your capital gains allowance in a general account, and not at all inside an ISA or a SIPP. Domicile in LU sets the withholding the fund itself suffers on the dividends it receives, a cost absent from the stated fee but present in the return.

Ongoing charges of 0.30% place this fund 12th of 24 comparable funds, whose median is 0.30%. On £10,000 that costs about 30 a year and 300 over ten years at a constant amount, deducted daily and never visible on a statement: it shows up in the gap between the fund's return and its index's. At this level, neither low enough to be an argument nor high enough to be an obstacle, the decision rests elsewhere: on the index tracked, on the distribution policy, and on what your broker charges to buy.

Replication is physical: the fund actually holds the constituents of MSCI Europe Small Cap, 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 0.30% headline. That is why two funds at the same price do not track their index with the same fidelity.

The domicile, Luxembourg, is not an administrative detail: it determines the withholding tax the fund suffers on the dividends it receives, and that loss appears in no fee table. Luxembourg has a comparable treaty network but is not as favourable as Ireland on US equities, a difference visible on a world index and not on a European one. For the holder, the UCITS framework also brings the key information document in their own language, diversification rules, and separation of the fund's assets from the issuer's.

Income is accumulated: dividends from the holdings are reinvested inside the fund rather than paid out. In a taxable account that defers taxation to the moment of sale instead of triggering it annually, leaving the whole return at work, and that is the main advantage of this share class. Two qualifications go with it. A holder who needs income has to sell units to obtain it, which is one more decision to take and sometimes at a bad moment. And the deferral is not universal: some countries tax a notional annual return whatever the distribution policy, in which case the accumulating class changes nothing.

With 3.7 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 Europe Small Cap, 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 Europe Small Cap covers smaller capitalisations, and the first effect is not return but liquidity: the underlying shares trade less, so the fund's spread between buying and selling price is wider and widens further in disturbed markets, precisely when one wants to sell. The second is amplitude: small caps fall more in a reversal and recover earlier in an upturn. The third is definition: what each provider calls small cap varies enough that two funds of the same name only partly overlap.

Over one year the fund shows -5.3% against 3.5% annualised over five years: the recent year lags the long average. Before drawing a conclusion, two possible causes have to be separated, because they have different consequences: a fall in the index tracked, which affects every fund replicating it, or a deterioration specific to the fund, which shows in the tracking difference rather than in the return.

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