Anyone who buys an ETF on the MSCI World often chooses between several products with the same index, the same costs and the same structure. But one detail determines the actual return: the fund domicile.
• ETFs with identical indexes can achieve different net returns despite having the same costs
• Irish-domiciled MSCI World ETFs often benefit from tax advantages compared to Luxembourg funds when it comes to US dividends
• Even a few basis points of return advantage per year can trigger noticeable differences in asset accumulation in the long term due to the compound interest effect
Same index, different location
Two ETFs on the same index, with the same total expense ratio and the same replication method can still have lasting differences in their returns. The reason lies not in the administration of the fund, but in its legal headquarters. The ISIN reveals where an ETF is located: abbreviations such as IE stand for Ireland, LU for Luxembourg. An Irish-domiciled MSCI World ETF and a Luxembourg competitor may track the same index, be physically replicable and equally accessible to German investors, but be measurably different in their net performance.
The double taxation agreement as a decisive factor
The core of the difference lies in the tax relationship between the fund domicile and the USA. The MSCI World consists largely of US companies, so the United States regularly makes up the largest share of the index. When these companies pay dividends, the US imposes a withholding tax. How high this is depends on the double taxation agreement between the USA and the country in which the receiving fund is based.
Ireland has a modern double taxation agreement with the USA, signed in Dublin on July 28, 1997. Pursuant to Article 10 of this Agreement, withholding tax on dividends paid to Irish funds is generally 15 percent. The US-Luxembourg Agreement was signed in Luxembourg on April 3, 1996 and entered into force on January 1, 2001. At first glance, both agreements seem comparable. The difference, however, lies in the practical application: Irish funds can usually take advantage of the favorable regulation immediately and in full, while Luxembourg funds do not always benefit from the most favorable conditions, depending on the contractual interpretation and fund structure. In practice, this means that Irish MSCI World ETFs often actually pay 15 percent withholding tax on US dividends, while Luxembourg counterparts sometimes have to pay the US standard tax rate of 30 percent.
What the difference means in concrete terms: an example calculation
The annual return advantage can be understood in three steps. The starting point is the typical US share in the MSCI World of around 70 percent. The dividend yield on the American market has historically been around 1.5 percent. This results in a dividend-relevant portfolio share of around 1.05 percent of the total fund (70 percent times 1.5 percent). The tax advantage on this amount is 15 percentage points, i.e. the difference between the higher tax rate applicable to Luxembourg funds and the 15 percent for Irish funds. This results in an annual return advantage of around 0.16 percent, i.e. around 16 basis points, in favor of the Irish-domiciled ETF. Assuming an additional annual return of 0.16 percentage points, an investor with a one-off investment of 10,000 euros would get an added value of around 220 euros after ten years, with otherwise identical market developments and an annual return of 7 percent. Over several decades and with regular savings plans, the effect can add up accordingly.
If you compare two structurally similar MSCI World ETFs with different domiciles based on their reported net performance, the magnitude of this effect can be understood in practice. The observable difference in returns between an Irish and a Luxembourg product cannot be entirely attributed to the domicile: part of the difference is explained by the respective cost difference between the TERs of both funds. If you adjust the difference for this cost effect, there is typically a remaining amount that reflects the different withholding tax burden on US dividends and the magnitude of which plausibly confirms the theoretically calculated around 16 basis points of withholding tax advantage. However, a direct one-to-one comparison always has limitations as both funds may have slightly different replication approaches and securities lending income, which also influence the result.
When the domicile plays a role and when it doesn’t
The effect described applies specifically to indices with a high US share. This effect is particularly pronounced at MSCI World because US stocks make up the majority of the index. For indices without a strong US weighting, such as pure European or emerging market ETFs, the fund domicile plays a significantly smaller role. So if you are looking for a fund based on European stocks or on the MSCI emerging markets, you will hardly notice any measurable difference between the Irish and Luxembourg variants.
For investors who are building a broadly diversified global ETF as a core investment, domicile is a concrete selection criterion. Both Ireland and Luxembourg are considered to be regulatory stable locations within the European Union that are established for fund construction. The difference lies not in the fund quality or security, but solely in the tax position compared to American dividends. The fund domicile is one of several criteria when selecting an ETF, but not one that should be neglected. Especially with long-term savings plans on the MSCI World, the tax treatment of US dividends can have a lasting impact on the real net performance. This is not a marketing advantage, but rather a structural difference that follows from the regulations of the respective double taxation agreements.
Jonas Vogt, editorial team at finanzen.net