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May 3, 2021

The Problem With Exchange Traded Funds (ETFs)

It’s likely you know what exchange traded funds (ETFs) are and how they can fit into your investment portfolio (hello diversification). But you might be surprised to learn that they may not be the best option for New Zealand investors. They are fantastic and have big advantages if you live in the USA or other countries, but if you live in New Zealand they could be costing you more money than you think.

Why? Let’s break it down…

First, tax

We know the word tax screams boring and is sleep-inducing for many, but stay with us!

Tax efficiency

It’s common that ETFs investing internationally end up not claiming all the tax credits, treaty benefits and refunds they’re owed. This is because either it’s hard work and doesn’t really benefit the fund manager, or the ETF doesn’t have the right structure to pass on these benefits to you as a NZ based investor. In turn, you miss out.

Now, you may think this tax “leakage” isn’t very important because it’s not often talked about. But depending on your personal tax rates and the investment strategy of the ETF, it could get as high as 1% per annum! A big expense over time and when investing larger sums of money.

Paying too much tax

NZ ETFs are classified as a listed PIE fund, meaning that each distribution (dividend) from the fund is automatically and immediately taxed at 28% – the highest Prescribed Interest Rate (PIR). Because of this, any investor with a lower PIR pays too much tax, which they can’t request back from the IRD until the following May via a tax return. If you are investing in an overseas ETF, the tax rate is your income tax rate which can be 33% or now even 39%.

Potential lost growth

The ETF practice in New Zealand is that tax is deducted from the distribution immediately and sits as cash within the fund. This isn’t eligible to be distributed to investors or invested in the market. This means you’re underinvested, and losing the potential growth this deduction can bring.

Contrastingly, Kernel’s funds as unlisted index funds (the fund itself is not listed on a stock exchange), avoid these issues. The tax is deducted at the correct PIR rate when selling units in the fund or the following April.

In other words, the money owed in tax can be used by the fund and the investor in the meantime. Distributions paid are higher as they are gross of tax, with the tax paid later and separately.

Second, trading costs

Brokerage fees

While ETF investors have the benefit of setting which price they want to buy and sell for (if they can find a willing buyer/seller at that price), this comes with higher trading costs than index funds.

The usual brokerage rate in New Zealand for retail investors is somewhere between 0.20% and 1.00%. This is a significant cost, especially if you are wanting to set up a regular investment plan into a fund.

With Kernel’s unlisted index funds, you purchase units directly with no transaction fees. Zero.

Another hidden cost with trading is buy and sell spread costs, which in essence becomes a brokerage fee. These are costs paid when buying and selling units in an ETF. They reflect the difference between the price at which investors can buy ETF units on an exchange and the price at which these units could be sold. It’s how the “market maker” makes their money at a cost to you. Find out more on buy and sell spreads here.

With Kernel due to our product design, there are no brokerage, buy-sell spreads, retail foreign exchange fees, or registry fees. This makes it more efficient when implementing a portfolio decision or regularly investing.

Foreign exchange fees

As a retail investor, when you buy an international ETF from New Zealand using an investment platform, it’s likely that you are paying a Foreign Exchange (FX) fee when exchanging your money from NZD into USD, or otherwise. This fee probably sits around 0.40% depending on the platform you’re using. As a fee, it doesn’t sound like a lot but can eat into you returns when you are investing larger amounts, and there’s a high chance you’re paying more than what larger institutional investors are paying to exchange their currency.

Comparatively, NZ based funds that are investing internationally on your behalf handle the effects of foreign exchange within the fund, at an institutional rate. The FX fee mentioned above is included in the fund, saving you the extra cost and hassle of figuring out what your total cost to invest is.

Third, dividend drag

Dividend drag is the lag between when ETFs receive a dividend payment and when it invests this money.

Why does this matter? Well, the more money that isn’t invested in the share markets at all times, the worst off the investor is. With ETFs, the above-mentioned tax payment and dividends paid by the companies in a fund, often sit as cash until it’s distributed to investors (up to months later). Furthermore, a portion of your purchase is actually held in cash to pay back to you as the next distribution. This drags the performance of the ETF units vs the actual performance of the index.

Kernel doesn’t do this, and is able to have all cash more than 99.9% invested, giving the investor the closest return to the index. This is known as the tracking difference cost. Lower tracking difference = lower cost.

Listed vs unlisted funds

Any fees paid to a fund manager eats into potential returns an investor makes.

While managing funds efficiently and to a high standard does have a cost, manging a listed fund does have a higher cost.

Because Kernel’s index funds are unlisted, we are able to avoid extra listing and registry fees that come along with being a fund listed on a stock exchange. Hence, we can keep our management fee lower, and pass on the extra returns to our investors. All the companies we invest in are listed on stock exchanges so the funds are still very liquid.

ETFs are listed funds and incur the previously mentioned listing and registry fees. This pushes their management fees up. More fees = less returns for investors.

Comparison of Global 100: ETFs vs Index Funds

To help paint the picture, let’s use an example. Let’s say Sarah and Alex both have $10,000 to invest in either a Kernel Global index fund, or an ETF listed on the New York Stock Exchange.

Sarah decides to invest $10,000 in an ETF and Alex in the Kernel Global 100 fund, both track the S&P Global 100 index. The key difference here is the investment type (vehicle) they are investing through.

When Sarah invests in an ETF, she must pay brokerage and FX conversion fees. Remembering that hidden tax leakage may occur and that brokerage and FX conversion fees are charged both when buying and selling units in a fund.

On the other hand, Alex who is investing in an index fund through Kernel doesn’t need to pay any brokerage or FX conversion fees, or account for tax leakage.

After 1 year of investing in an ETF Sarah will be left with an actual return of 4.67% (after tax and fees). Her initial $10,000 investment will have grown to $10,467. Whereas Alex’s initial investment of $10,000 into the Kernel Global 100 fund will have grown 5.15% to $10,515.

The more money invested, the bigger the difference

The difference between the actual return of investing in an ETF is also magnified if Sarah and Alex were to have more money invested. For example if Sarah had a total of $50,000 invested overseas, the tax is even higher and her actual return would be just 3.62%. Meanwhile if Alex has over $25,000 invested in Kernel funds, her actual return would be 5.35% as Kernel has 0.10% lower fees for larger investors. That’s quite the difference over the long term!


Kernel Fund

US ETF (Under $50k Overseas)

US ETF (Over $50,000 Overseas)

Management fee




Tax rate




Tax leakage




Brokerage fee




FX Conversion fee




Total tax and fees*




*over the time period of one year.

As you can see, the impact of tax and fees combined are higher when investing in any internationally listed ETFs compared with a Kernel fund over the time period of one year. While the difference may seem somewhat insignificant, over a longer period of time and as the amount you’re investing increases this can work out to be significant.

With Kernel, there are no transaction costs, and all funds are currently in NZD so there are no FX Conversion fees.

To summarise

While management fees are important for both ETFs and index funds, there’s hidden costs to investing in different types of investment structures.

At Kernel, we’re focused on the subtleties to maximize returns for you as an investor. Good fund design, coupled with great indices that have proven value over time, will give you a better return. And greater returns are ultimately what every investor is striving for when they invest!

Dean Anderson

Founder & Chief Executive


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Indices provided by: S&P Dow Jones Indices