MOIC vs IRR

By / Alternative Investments

IRR and MOIC are two popular performance metrics, especially within “alternative” investment asset classes such as real estate, private equity, and venture capital (where time-weighted returns are essentially meaningless). Both IRR and MOIC are important metrics, but neither should be used in isolation when comparing a fund’s performance; investors should always evaluate both within the context of the other (as well as expenses, since MOIC and IRR are often quoted on a gross basis).

IRR

IRR Definition

IRR stands for Internal Rate of Return. IRR is the discount rate one would need to use so that the net present value (NPV) of all future cash flows is zero. In other words, one would look at all the contributions into and distributions from an investment and then find the rate that discounts the sum to zero. IRR is not a perfect way to calculate returns, but it is one of the better metrics for many real estate, private equity, and venture capital assets (among others). IRR can be quoted on a gross or net of fees basis.

IRR Formula

Mathematically, IRR is variable than enables the sum of the NPV of cashflows to equal zero. The bad news is that the equation below is the formula used to derive IRR. The good news is that many calculators, Microsoft Excel, and Google Sheets can calculate IRR.

Source: ThoughtfulFinance.com

IRR Example & IRR Calculation

The IRR calculation is complex, but a calculator can do it relatively quickly. If I’m in rush or want to get a ballpark estimate, I’ll simply google “IRR calculator.” Microsoft Excel and Google Sheets also have IRR (if periodic cashflows) and XIRR (if non-periodic cashflows) functions.

Using an online calculator, Excel, or Sheets, we can input the below hypothetical cash flows and determine that the IRR is 42%.

Initial Investment$100,000
Year 1 Cash Flow$125,000
Year 2 Cash Flow$10,000
Year 3 Cash Flow (final distribution)$20,000
IRR42%
Source: ThoughtfulFinance.com

IRR: Pros & Cons

Pros of IRR

  • One the primary reasons that IRR is the default performance reporting metric for alternative investments is that it accounts for varying amounts of capital. Many alternative investments are funded over time and distributions are also made over time.
  • IRR accounts for the time value of money, unlike MOIC which does not account for time at all.
  • IRR is very sensitive to several factors that (within a fund context) encourage managers to only call capital when it is needed and to return capital to investors relatively quickly. As we will see later, this can also be a negative.

Cons of IRR

Despite the above pros, IRR is not necessarily sufficient to evaluate investment performance for a few reasons.

  • As illustrated in our example and mentioned in the “pros” section above, IRR is sensitive to early cash flows and small (often inconsequential) distributions early on can elevate IRR for years.
  • IRR calculations begin when capital is put to work. However, it does not account for the opportunity cost of uncalled capital. Uncalled capital is often generating low(er) returns since it needs to be relatively liquid.
  • On the flip side, IRR does not account for the time after capital is returned to investors. In the above example, capital was returned relatively quickly (which could be a pro or con for the investor, depending on their opportunity set available).
  • Lastly, IRR’s are based on cash flows and cash flows can be changed without impacting performance. In other words, IRR can be influenced (or manipulated) relatively easily.
    • Subscription lines: Funds have increasingly used “subscription lines” to defer calling investor capital. The leverage allows funds to buy assets and generate returns early on. The funds can then distribute more capital back to investors earlier. Sounds great, except the leverage has a cost and is simply in lieu of called capital (rather than in addition to). This inflates the IRR while often reducing economic returns (due to interest and administrative expenses).
    • Leverage & Dividend Recaps: Assume an investor buys a building for $10 million and it generates $2 million of cash flow in the first year. The IRR would be 20%. However, if the investor decides to borrow 90% of the buildings value and pocket the proceeds, the investor has now taken $11 million out of the investment ($2 million of cash flow and $9 million of cash out refinance proceeds). The IRR jumps from 20% to 200% without any difference in economic returns (the investor may actually be worse off, since they now have to pay interest on the loan).
  • Performance fees (carry, promote, incentive, etc.) are often based on IRR, even though it is not necessarily representative of actual dollar returns.
  • Similar to MOIC, IRR is simply an estimate at any point before all all returns have been realized.
  • Since MOIC is generally quoted on a gross basis, gross IRRs can vary wildly from net IRRs. Investors should calculate net IRRs if needed.

MOIC

MOIC Definition

MOIC stands for Multiple On Invested Capital. It expresses returns as a multiple of investment. MOIC is typically quoted on a gross basis (so before expenses such as fees are deducted and taken into account).

MOIC Formula

MOIC Example

Let’s use the above numbers (from our IRR example above) to calculate MOIC. The initial investment is $100,000. The asset generates total proceeds of $155,000 through its life. In this case the MOIC is 1.55x.

MOIC Calculation

In the above example, we get 1.55x by adding $125,000 from Year 1, $10,000 from Year 2, and $20,000 from Year 3 and dividing by $100,000.

MOIC: Pros & Cons

Pros of MOIC

  • MOIC is relatively easy to calculate (even in your head) and easily understood intuitively. Thus, a main benefit of MOIC is that conveys the actual dollar return (gross of fees, generally).
    • In the above IRR example, the IRR is 42%. So a prospective investor may mistakenly extrapolate that the next (similar) investment will grow to approximately 286,000 over three years (assuming a 42% return compounded annually). However, the investment only grew to $155,000 over three years.

Cons of MOIC

  • One of the downsides of MOIC is that it does not account for time value of money. MOICs can grow quite large by just holding assets for a long time, so MOIC must be evaluated within the context of time.
    • As an example, is a 3x MOIC or a 4x MOIC better? Nobody can say unless they know what the time periods are. If the 3x MOIC was generated in two years and the 4x MOIC over 8 years, I’d say that the 3x investment was the better one.
  • Another weakness of MOIC is that it does not account for varying amounts of capital. It is quite easy to understand if capital is all invested at once. But what if capital is called/invested over time?
    • For instance, assume 10% of capital is invested in Year 1 and doubles in value. An additional 10% of capital is invested in Year 2 and then the asset value doubles again. Then 80% of capital is invested in Year 3 and there are no distributions or change in value through Year 5. The MOIC after five years is 1.6x. Is this good or bad return? The returns were great the first two years and terrible during the last three years (when the majority of capital was invested).
  • Similar to IRR, MOIC is simply an estimate at any point before all capital has been returned to investors.
  • MOIC is generally quoted on a gross basis. Investors should account for fees and expenses in these cases.
  • MOIC is often a performance metric for individual fund assets, which can differ quite a bit from fund-level performance. For fund-level performance, investors may want to consider using TVPI rather than MOIC.

MOIC vs IRR

Similarities

MOIC and IRR are different but do have some similarities:

  • Are preferable to time-weighted return (TWR) in many scenarios.
  • Widely used in the (alternative) investment industry.

Differences

As readers can glean from the above, there are some important differences between MOIC and IRR:

  • IRR represents the time value of money, but MOIC represents the multiple of money.
  • IRR is relatively sensitive to inputs (and easier to engineer/manipulate); it is more difficult to do this with MOIC.
  • IRRs are generally higher early in an investment’s life; MOIC is generally higher later in an investment’s life.
  • MOIC is generally quoted on a gross basis, while IRR is quoted on a gross or net basis.

Using MOIC and IRR Together

Both MOIC and IRR have strengths and weaknesses, but neither should be used in isolation. Unfortunately, many investment managers and funds often advertise IRR or MOIC but not both. Investors wanting to understand performance should be evaluating both MOIC and IRR within the context of expenses and other factors such as leverage, pacing, etc.

IRR MOIC Table

One resource that may be helpful is the below IRR MOIC table, which models the relationship between IRRs, multiples (such as MOIC), and hold time. Of course, each investment is unique with caveats and there is no standard MOIC to IRR formula or calculator (since the inputs can vary quite a bit especially for IRR). In the absence of a IRR to MOIC conversion formula, the below MOIC IRR table is a great resource (although it may or may not hold in each case depending on an investment’s details).

IRR MOIC Table
Source: ThoughtfulFinance.com

As an investor, one of the first things I do when evaluating a fund’s pitch or performance is to ensure that I have IRR and MOIC data as well as an understanding of the size/pacing of capital calls and distributions. If this information is not provided initially, I will ask for it and most managers can provide it relatively quickly. But I will not make an investment without looking at and understanding both IRR and MOIC.

IRR vs TVPI

By / Alternative Investments

IRR and TVPI are two popular performance metrics, especially within “alternative” investment asset classes such as real estate, private equity, and venture capital (where time-weighted returns are essentially meaningless). Both IRR and TVPI are important metrics, but neither should be used in isolation when comparing a fund’s performance; investors should always evaluate both within the context of the other.

IRR

IRR Definition

IRR stands for Internal Rate of Return. IRR is the discount rate one would need to use so that the net present value (NPV) of all future cash flows is zero. In other words, one would look at all the contributions into and distributions from an investment and then find the rate that discounts the sum to zero. IRR is not a perfect way to calculate returns, but it is one of the better metrics for many real estate, private equity, and venture capital funds (among others). IRR can be quoted on a gross or net of fees basis.

IRR Formula

Mathematically, IRR is variable than enables the sum of the NPV of cashflows to equal zero. The bad news is that the equation below is the formula used to derive IRR. The good news is that many calculators, Microsoft Excel, and Google Sheets can calculate IRR.

Source: ThoughtfulFinance.com

IRR Example & IRR Calculation

The IRR calculation is complex, but a calculator can do it relatively quickly. If I’m in rush or want to get a ballpark estimate, I’ll simply google “IRR calculator.” Microsoft Excel and Google Sheets also have IRR (if periodic cashflows) and XIRR (if non-periodic cashflows) functions.

Using an online calculator, Excel, or Sheets, we can input the below hypothetical cash flows and determine that the IRR is 42%.

Initial Investment$100,000
Year 1 Cash Flow$125,000
Year 2 Cash Flow$10,000
Year 3 Cash Flow (final distribution)$20,000
IRR42%
Source: ThoughtfulFinance.com

IRR: Pros & Cons

Pros of IRR

  • One the primary reasons that IRR is the default performance reporting metric for alternative investments is that it accounts for varying amounts of capital. Many alternative investments are funded over time and distributions are also made over time.
  • IRR accounts for the time value of money, unlike TVPI which does not account for time at all.
  • IRR is very sensitive to several factors that (within a fund context) encourage managers to only call capital when it is needed and to return capital to investors relatively quickly. As we will see later, this can also be a negative.

Cons of IRR

Despite the above pros, IRR is not necessarily sufficient to evaluate investment performance for a few reasons.

  • As illustrated in our example and mentioned in the “pros” section above, IRR is sensitive to early cash flows and small (often inconsequential) distributions early on can elevate IRR for years.
  • IRR calculations begin when capital is put to work. However, it does not account for the opportunity cost of uncalled capital. Uncalled capital is often generating low(er) returns since it needs to be relatively liquid.
  • On the flip side, IRR does not account for the time after capital is returned to investors. In the above example, capital was returned relatively quickly (which could be a pro or con for the investor, depending on their opportunity set available).
  • Lastly, IRR’s are based on cash flows and cash flows can be changed without impacting performance. In other words, IRR can be influenced (or manipulated) relatively easily.
    • Subscription lines: Funds have increasingly used “subscription lines” to defer calling investor capital. The leverage allows funds to buy assets and generate returns early on. The funds can then distribute more capital back to investors earlier. Sounds great, except the leverage has a cost and is simply in lieu of called capital (rather than in addition to). This inflates the IRR while often reducing economic returns (due to interest and administrative expenses).
    • Leverage & Dividend Recaps: Assume an investor buys a building for $10 million and it generates $2 million of cash flow in the first year. The IRR would be 20%. However, if the investor decides to borrow 90% of the buildings value and pocket the proceeds, the investor has now taken $11 million out of the investment ($2 million of cash flow and $9 million of cash out refinance proceeds). The IRR jumps from 20% to 200% without any difference in economic returns (the investor may actually be worse off, since they now have to pay interest on the loan).
  • Performance fees (carry, promote, incentive, etc.) are often based on IRR, even though it is not necessarily representative of actual dollar returns.
  • Similar to TVPI, IRR is simply an estimate at any point before all capital has been returned to investors.

TVPI

TVPI Definition

TVPI stands for Total Value to Paid In. It expressed return as a multiple of “paid-in capital.” Paid-in capital is the money that an investor invests in a fund (regardless of how much is actually invested by the fund), so TVPI is often used to measure the performance of fund investments. TVPI can be quoted on a gross or net of fees basis.

TVPI Formula

TVPI Example

Let’s use the above numbers (from our IRR example above) to calculate TVPI. The initial investment is $100,000. The investor receives a total of $155,000 through the life of the investment. In this case the TVPI is 1.55x.

TVPI Calculation

In the above example, we get 1.55x by adding $125,000 from Year 1, $10,000 from Year 2, and $20,000 from Year 3 and dividing by $100,000.

TVPI: Pros & Cons

Pros of TVPI

  • TVPI is relatively easy to calculate (even in your head) and easily understood intuitively. Thus, a main benefit of TVPI is that conveys the actual dollar return to investors.
    • In the above IRR example, the IRR is 42%. So a prospective investor may mistakenly extrapolate that their next investment would grow to approximately 286,000 over three years (assuming a 42% return compounded annually). However, the investment only grew to $155,000 over three years.

Cons of TVPI

  • One of the downsides of TVPI is that it does not account for time value of money. TVPIs can grow quite large by just holding assets for a long time, so TVPI must be evaluated within the context of time.
    • As an example, is a 2xTVPI or a 5x TVPI better? Nobody can say unless they know what the time periods are. If the 2x TVPI was generated in one year and the 5x TVPI over 12 years, I’d say that the 2x investment was the better one.
  • Another weakness of TVPI is that it does not account for varying amounts of capital. It is quite easy to understand if capital is all invested at once. But what if capital is called/invested over time?
    • For instance, assume 10% of capital is called in Year 1 and doubles. An additional 10% of capital is called in Year 2 and then the fund value doubles again. Then 80% of capital is called in Year 3 and there are no distributions or change in value through Year 5. The TVPI after five years is 1.6x. Is this good or bad return? The returns were great the first two years and terrible during the last three years (when the majority of capital was invested).
  • Similar to IRR, TVPI is simply an estimate at any point before all capital has been returned to investors.

TVPI vs IRR

Similarities

TVPI and IRR are different but do have some similarities:

  • Quoted on a gross or net basis (read more about gross vs net IRR).
  • Are preferable to time-weighted return (TWR) in many scenarios.
  • Widely used in the (alternative) investment industry.

Differences

As readers can glean from the above, there are some important differences between TVPI and IRR:

  • IRR represents the time value of money, but TVPI represents the multiple of money.
  • IRR is relatively sensitive to inputs (and easier to engineer/manipulate); it is more difficult to do this with TVPI.
  • IRRs are generally higher early in an investment’s life; TVPI is generally higher later in an investment’s life.

Using TVPI and IRR Together

Both TVPI and IRR have strengths and weaknesses, but neither should be used in isolation. Unfortunately, many investment managers and funds only advertise IRR or TVPI but not both. Investors wanting to understand performance should be evaluating both TVPI, IRR, and other factors such as leverage, pacing, etc.

One resource that may be helpful is the below table, which models the relationship between IRRs, multiples (such as TVPI), and hold time. Of course, each investment is unique with caveats, so this table may or may not hold in each case but I find it is a good general resource.

Source: ThoughtfulFinance.com

As an investor, one of the first things I do when evaluating a fund is to ensure that I have IRR and TVPI data as well as an understanding of the size/pacing of capital calls and distributions. If this information is not provided initially, I will ask for it and most managers can provide it relatively quickly. But I will not make an investment without looking at and understanding both IRR and TVPI.

Vanguard Mutual Fund & ETF Share Class Structure

By / Uncategorized

Vanguard is one of the largest asset managers in the world and their funds use a unique share class structure that includes ETFs. Vanguard ETFs are essentially a share class of their mutual funds. This patented structure generates tax benefits for Vanguard mutual fund owners. Like many mutual fund complexes, Vanguard offers a variety of institutional and retail share classes. Individual investors generally have access to the following Vanguard share classes:

  • Investor Shares
  • Admiral Shares
  • ETFs

Readers interested in current funds available, minimums, etc., should check out Vanguard’s share class page and read below for a general overview of how Vanguard’s share classes work.

Vanguard Mutual Fund Share Classes: Admiral Shares vs Investor Shares

Investor Shares

Many of the mutual funds that Vanguard initially offered to individual investors were from the Investor share class, or “Investor Shares.”

Over time, Vanguard has phased many index fund Investor Shares, although Investor Shares remain open for many of their non-index actively-managed funds. In some cases, the funds closed to new investors (but remain open to existing investors wishing to increase allocations). In other cases, the funds were merged with other funds or consolidated into the Admiral share class.

There are different business reasons for each phase out, but investors are not necessarily missing out. The Investor Shares are generally the most expensive share class of each Vanguard fund.

Admiral Shares

The Admiral share class was launched back in 2000. Originally, these “Admiral Shares” had higher investment minimums and lower expenses than the Investor Shares. However, the Admiral Shares are now the only mutual fund share class available to many investors. Fortunately, the minimum investment for many Admiral Shares is down to $3,000.

Vanguard’s ETF (share class)

Vanguard began launching ETFs in 2001. Interestingly and importantly, is the Vanguard ETF share class structure; many Vanguard ETFs are structured as a share class of their mutual funds. Just as Investor Shares shares and Admiral Shares shares are different share classes of single funds, ETFs are also a share class of the same fund. Vanguard patented this innovation, although that patent expires in May 2023.

ETF Tax-Efficiency

ETFs are generally more tax-efficient than mutual funds due to ETFs’ ability to make “in-kind” redemptions. That is, the fund pays the redeeming investor in stock or bonds rather than cash.

When an investor redeems shares of a mutual fund, the fund must sell assets to raise cash to pay the investor. These sales often realize capital gains and funds are obligated to make a taxable distribution based on any net capital gains.

When shares of an ETF are redeemed, the fund can distribute fund assets in-kind (rather than selling to raise cash). Since no sales are made, no capital gains are realized. If no capital gains are realized, then no taxable distributions will be made. (Note: ETFs are typically traded between investors on an exchange. However, some shares are also created and redeemed by Authorized Participants [APs]).

Tax-Efficiency of Vanguard Mutual Funds

ETFs are able to avoid realizing a lot of capital gains by making in-kind distributions from the pool of assets that they represent. In the cases where a Vanguard ETF is one of several share classes, then the ETF and the other mutual fund share classes represent the same pool of assets. This means that a Vanguard ETF’s in-kind distributions benefit both itself and its related share classes. Thus, Vanguard mutual funds are generally just as tax-efficient as ETFs.

Bond ETF Risks

ETFs are generally more tax-efficient than similar mutual funds, but that is not necessarily the case with Vanguard. So the decision to use an ETF versus an Admiral Share is often a close call and may not make any difference at all.

The one asset class where I almost always use mutual funds rather than ETFs is fixed-income. I’ve written extensively about the risks of bond indices and bond ETFs, but the tl;dr version is that indexing is not quite a beneficial for fixed-income (relative to equities), the major bond indices have problems, and ETFs are not a well-suited for fixed-income. There are some exceptions, but I generally steer clear of fixed-income ETFs.

Vanguard Share Class Conversions

Investor Share Class to Admiral Share Class Conversion

Vanguard’s share class conversion program allows holders of Investor Shares to convert their holdings to Admiral Shares. The conversion only works in one direction, so Admiral share class owners cannot convert their shares into Investor Shares. A tutorial on how to make this conversion is on Vanguard’s website.

Vanguard Mutual Fund to ETF Conversion

Vanguard’s share class conversion program also allows investors in some of its mutual funds to convert their shares from the mutual fund share classes to the ETF share class. This conversion only works in one direction, so ETF holders cannot convert from ETFs to a mutual fund share class. A full list of funds eligible for share class conversion can be found on Vanguard’s site.

Implications for Investors

The answer to the question of whether to use Vanguard Admiral Shares vs Investor Shares is: it depends.

The decision to use Investor Shares, Admiral Shares, or ETFs depends on investor-specific factors, such as custodian/brokerage, portfolio and allocation size, transaction costs, tax profile, liquidity needs, and so on. Investors should evaluate these factors in the context of their own situation.

Bond Index Risks & Bond ETF Risks

By / Uncategorized

This is an evidence-based website and there is sufficient evidence that index-based investing is one of the best ways to invest… in equities. The case for index investing is much less compelling for fixed-income (aka bonds). The asset class is not well-suited for passive management, the indices have some issues, and bond index funds are exposed to some major risks.

These risks can be exacerbated if the index fund happens to be an ETF. This post is not only or necessarily a case for “why bond ETFs are bad,” but it does highlight some of the bond ETF risks that investors should consider.

Why Passive Investing Makes Less Sense for Bonds

Bonds Are Not Tax Efficient

One of the primary benefits of passive management or index investing is tax-efficiency. In short, fewer trades generally leads to less realized capital gains (resulting in lower tax liability). This low turnover approach works well for equities where appreciation is the major contributor to performance (with dividends contributing less historically). However, interest income is the major contributor to fixed-income returns with appreciation playing a minor role (if any at all). Thus, while low turnover can help equity investors turn short-term gains into long-term gains or allow capital to compound tax-deferred for longer, there is rarely such benefit for fixed-income investors.

Bond Returns Are Capped

Related to the above two issues is the attribution of returns. Within equities, a small rolling cohort of stocks is responsible for the majority of returns. There is a downside to not owning everything as returns from a minority of “winners” will more than offset losses from the majority of “losers.” Within fixed-income, future returns are more or less known as they generally consist of fixed interest payments (hence the name “fixed-income”). So there is little (if any) benefit to owning everything and there is a downside because defaults will decrease returns. Fixed-income investors should diversify enough while also avoiding the worst borrowers.

Bond Index Risks

Bond Index Construction

The construction of many fixed-income indices can also be problematic. Many indices are capitalization (“cap”) weighted. For equity indices, this means that larger companies constitute larger portions of the index. For fixed-income indices, this means that entities with the most debt constitute larger portions of the index. Of course, this is not necessarily desirable and we believe there are much better methodologies to weight portfolios.

Bond Index Fund Risks

Bonds Are Illiquid

Unlike equity markets where shares of nearly every public company trade every day, fixed-income markets are not nearly as liquid. Many fixed-income assets do not even trade on a central exchange, but rather via phone, chat, and even by appointment. On any given day, most municipal bonds do not trade at all and many do not trade for months at a time. Most high yield bonds do not trade every day nor do a large portion of investment grade bonds. Recall that an index fund’s objective is to mirror the risk and return of an index, not to maximize performance. Index funds are forced buyers and sellers; if cash comes in they must buy and they must sell if they receive redemption requests. This is not necessarily a problem for equity index funds because equities are fairly liquid. However, what happens if a fixed-income funds needs to sell into a skittish market or buy into ebullient one?

As volatility increases and liquidity declines, it is very difficult to value bonds. Fixed-income markets can and do freeze (except for forced transactions such as liquidations and distressed sellers). Being forced to sell into an illiquid market with no bids is not something anyone wants to do, but some investors are forced to do it. Imagine an index mutual fund or ETF receiving investor redemptions; those funds HAVE to sell.

Bonds Can Be Difficult To Value

How does this impact fixed-income index funds? Fixed-income fund “net asset values” (NAV) are typically derived using the “bid” (the price that someone is willing to buy a bond for, rather than the “ask” or what some is willing to sell for). So, what happens when a market is frozen and there are no bids? What happens when nobody wants to buy and everyone knows that there are forced sellers and bids are lowered to fire sale prices? Funds have difficulty pricing their holdings and valuing their portfolios, so NAVs are all over the place. Within the fixed-income ETF universe, many funds trade at deep discounts to NAV because investors do not trust the ETF’s reported NAV.

Not all ETFs are created equal, but even the largest and most liquid fixed-income ETFs are not immune from the above issues (of course, the discounts on smaller and less liquid ETFs was much larger than the examples shown above). Every product wrapper possesses a unique set of pros and cons and some suit particular asset classes better than others. We encourage investors to understand these dynamics and evaluate the risks before allocating to fixed-income ETFs.

Bond ETFs: Pros and Cons

In addition to issues that fixed-income indices and index funds face, the exchange-traded fund (ETF) wrapper can create additional problems for fixed-income investors.

Why Bond ETFs Are Bad

Fixed-income ETFs frequently trade at a discount to their net asset value during times of stress. One the largest and most liquid bond ETFs, iShare’s TLT, traded nearly 5% below its NAV in March 2020!

Perhaps even more interestingly, at one point in March 2020, Vanguard’s ETF BND traded more 6% below what mutual fund shares on the same portfolio traded at (many Vanguard ETFs are a share class of existing mutual fund portfolios, so those ETFs and mutual funds own the same underlying portfolio)!

Some argue that ETFs provide better price discovery and that ETF market prices are more accurate than NAVs. I am are sympathetic to this argument, but investors prefer to sell at higher prices rather than lower prices (no matter how interesting academic questions about price discovery might be). All else being equal, it is difficult for me to buy a fixed-income ETF knowing that this large risk exists (even if it realized infrequently).

Bond ETF Tax-Efficiency

Of course, a major advantage of ETFs is the tax-efficiency created by “in-kind” creations and redemptions of fund shares. This can provide a material benefit to equity investors who want to minimize turnover for tax purposes, but is of limited benefit to fixed-income investors whose returns consist primarily of interest. Additionally, many fixed-income ETFs utilize create/redeem using cash rather than in-kind securities.

When Bond ETFs Can Be Good

Despite the above, I believe there are a few use cases for Bond ETFs.

  • Bond ETFs are generally more liquid than the bonds that they hold. So investors who like to trade a lot may be better off using an ETF.
  • Investors who monitor markets closely and are able to sell at the first signs of market distress.
  • Long-term investors who do not mind if their holdings trade at a wide discount to NAV.
  • Foreign investors who may not be able to buy many US-domiciled mutual funds.

Final Thoughts

My personal view is that investors should allocate to index-based strategies for equity exposure and actively-managed strategies for fixed-income exposure due to the issues listed above. However, every investor is different and must weigh the above factors for themselves.

Gross IRR vs Net IRR

By / Alternative Investments, Terminology

Internal Rate of Return (IRR) is the default performance reporting metric for many private market assets, from real estate to private equity and venture capital. Unfortunately, IRR is complex to calculate and not an intuitive metric for most investors, so calculators/spreadsheets are a must to determine and compare both gross IRR and net IRR.

Nearly all investments incur expenses and so there is a difference between gross and net performance. Gross IRR does not include expenses and represents performance before expenses, while net IRR includes expenses and thus represents performance after expenses. Investors evaluating any type of performance should compare gross vs net performance, including gross IRR vs net IRR.

Gross IRR

Technically, IRR is the discount rate one would need to use so that the net present value (NPV) of all future cash flows is zero. Gross IRR considers the cash flows before the deduction of expenses, so the cash flow inputs and resulting IRR are higher than with net IRR.

Gross IRR Calculation & Example

The IRR calculation is complex, but a calculator can do it relatively quickly. If I’m in rush or want to get a ballpark estimate, I’ll simply google “IRR calculator.” Microsoft Excel and Google Sheets also have IRR (if periodic cashflows) and XIRR (if non-periodic cashflows) functions.

Using an online calculator, Excel, or Sheets, we can input the below cash flows and determine that the IRR is 17.5%.

Initial Investment$100,000
Year 1 Cash Flow$10,000
Year 2 Cash Flow$20,000
Year 3 Cash Flow (final distribution)$125,000
IRR17.5%
Source: ThoughtfulFinance.com

Net IRR

As stated above, IRR is the discount rate one would need to use so that the net present value (NPV) of all future cash flows is zero. Net IRR considers the cash flows after the deduction of expenses, so the cash flow inputs and resulting IRR are lower than with gross IRR.

Net IRR Calculation & Example

As mentioned above, the IRR calculation is complex, but a calculator can do it relatively quickly. If I’m in rush or want to get a ballpark estimate, I’ll simply google “IRR calculator.” Microsoft Excel and Google Sheets also have IRR (if periodic cashflows) and XIRR (if non-periodic cashflows) functions.

The main difference when calculating net IRR vs gross IRR is that we’ll have to adjust the amounts of the cashflows. In the below example, we will add a 10% performance fee (carry/promote/incentive) to the cash flows of the above example. Therefore, the cash flows will only be 90% of the cash flows in the gross IRR example above.

Using an online calculator, Excel, or Sheets, we can input the below cash flows and determine that the IRR is 13%.

Initial Investment$100,000
Year 1 Cash Flow$9,000
Year 2 Cash Flow$18,000
Year 3 Cash Flow (final distribution)$112,500
IRR13.0%
Source: ThoughtfulFinance.com

Gross vs Net IRR: Calculation Differences

As the above examples show, the main difference between gross IRR vs net IRR calculations is the impact of expenses on the cash flow inputs used in the calculation. The calculation remains the same, but the inputs need to be adjusted beforehand. Common adjustments include:

  • Upfront or one-time fees at the fund level
  • Upfront or one-time fees at the asset level
  • Expenses (such as legal, accounting, audit, etc.)
  • Management fees
  • Performance fees (carry, promote, incentive, etc.)
  • Exit/disposition fees

There may be others, but these are the ones that I observe most frequently.

Gross vs Net IRR in Private Equity

Although IRR is a common reporting metric, there is variation in how it’s reported. Some default to reporting gross IRR, while others default to net IRR.

The most common practice seems to be reporting net IRR at the fund level. All fund expenses and investor-level fees are deducted, with the caveat that the performance of any single investor will vary.

There are a few reasons that investor-level returns deviate from fund -level returns. Different investors often pay different fees (and reporting a multitude of individualized net IRRs is not feasible). Early investors often receive discounts and larger investors qualify for fee breakpoints.

Reporting an investor -level IRR is further complicated by the fact that investors may have invested at different points in time. Even if there are equalization terms and catch-up interest is paid, there are timing differences that could impact an investors IRR. Additionally, it is not uncommon for equalization to adjust the equity or NAV for investors, but allow early investors to keep the income distributions that they already received.

Some sponsors report gross IRR and some may report IRR that is net of non-fee expenses and gross of fees. Still others might report non-IRR performance metrics like MOIC or TVPI or not report anything at all! Even if IRR is reported though, it is important that investors understand if it is gross IRR, net IRR, or some hybrid IRR, as well as how it is derived.

VTEAX vs VTEB

By / Fund Comparison

The Vanguard Tax-Exempt Bond Index Fund (Admiral Shares) (symbol VTEAX) and the Vanguard Tax-Exempt Bond Index ETF (symbol VTEB) are two of the largest and most popular municipal (muni) bond index funds. Some compare VTEAX vs VTEB not realizing that they are just two different share classes of the same portfolio.

A quick reminder that this site does NOT provide investment recommendations. Fund comparisons (such as this one) are not conducted to identify the “best” fund (since that will vary from investor to investor based on investor-specific factors). Rather, these fund comparison posts are designed to identify and distinguish between the fund details that matter versus the ones that don’t.

The Short Answer

VTEAX and VTEB are different share classes of the same portfolio. The decision to buy one or the other depends on investor-specific factors (some of which are listed below).

The Longer Answer

Vanguard ETFs are structured as share classes of their mutual funds. This is a patented structure that is scheduled to expire in 2023, so we may see this structure more frequently in the near future. In other words, VTEAX and VTEB are not two funds pursuing an identical strategy; they are the same fund! Read more about Vanguard’s share class structure and the potential benefits.

Historical Performance: VTEAX vs VTEB

VTEB was launched on August 21, 2015 and VTEAX was launched a few days later on August 25, 2015. Perhaps not surprisingly, performance has been nearly identical since that time: 1.83% vs 1.89% annually. Despite changes in fees and expenses over that time period, the cumulative difference in performance over that time period is less than 50 basis points! Looking at the chart of VTEAX vs VTEB below, it is obvious that they are identical.

Risks of Fixed-Income ETFs

One of the risks of fixed-income ETFs is that they trade well below their net asset value (NAV) in times of distress. This is clear if we chart VTEAX vs VTEB during the first half of 2020. VTEB declined over 17.5% (peak-to-trough), while VTEAX “only” declined roughly 11.5%. Remember, these are simply different share classes of the exact same fund! However, VTEB trades at a market price and VTEAX is traded at a NAV.

This is caused by the fact that fixed-income typically trades at wide bid-ask spreads, which widen even further during market volatility. Sometimes the bids will disappear altogether. Mutual funds generally publish a NAV based on market prices (or estimated values for fixed-income), so estimating a NAV is difficult if the market freezes or bids disappear.

The consensus is that ETFs provide better “price discovery” than mutual funds, since ETFs represent actual market prices. In this example, it is widely assumed that the VTEB value was closer to value of the underlying portfolio than the VTEAX NAV. Interestingly, holders of VTEAX could have sold their holdings and rotated into VTEB (which is the exact same portfolio) at a substantial discount.

Differences Between VTEAX and VTEB

Since the two funds are actually two share classes of the same fund, I will skip the usual comparisons here. The geographic exposures, sector weights, market cap coverage so on is identical because the two funds are shares in the same portfolio. There are some resources on the internet indicating otherwise, but these are incorrect.

Factors to Consider

Transaction Costs

ETFs are free to trade at many brokers and custodians, including Vanguard. However, many brokers and custodians still charge commissions and/or transaction fees to buy/sell mutual funds. To my knowledge, Vanguard does not participate in the pay-to-play arrangements that would allow their mutual funds to trade for free on many platforms. So if an investor account is at Vanguard, it is free to trade VTEAX or VTEB. However, only VTEB is free to trade in non-Vanguard accounts.

There is a bid-ask spread when trading ETFs, but this spread is typically less than .02% for VTEB and individual investor trades will not generally be large enough to “move” the market. In the case of VTEB, individual investors should not have a problem trading.

Tax Efficiency & Capital Gain Distributions

ETFs are typically more tax-efficient than mutual funds, due to their ability to avoid realizing capital gains through like-kind redemptions (a process that is beyond the scope of this post). However, since Vanguard ETFs are a share class of their mutual funds, the mutual funds are able to benefit from this feature of the ETF. In other words, VTEB is able to extend its tax benefits to VTEAX.

One additional consideration is that fixed-income ETFs are not quite as tax-efficient as equity ETFs. Neither VTEAX nor VTEB have ever made a capital gains distribution. I noticed some posts on the internet saying that VTEB is more tax-efficient than VTEAX, but this incorrect.

Tax Loss Harvesting

My personal preference is to keep a portfolio entirely mutual funds or entirely ETFs, due to the mechanics of settlement during tax loss harvesting. If an ETF has declined in value and an investor sells it, the trade and cash proceeds will not settle for two business days (T+2). That investor may want to “replace” the sold ETF immediately and attempt to buy another ETF or mutual fund simultaneously.

However, mutual funds settle on T+1 basis, so cash for the mutual purchase would be due in one business day (which is one day earlier than the cash from the ETF sale is received). This can obviously cause problems and (even though this issue can be addressed with careful planning) I find it easier to keep accounts invested in similar vehicles. In this case, if a portfolio is all mutual funds, I might lean more towards VTEAX. If all ETFs, I might lean more towards VTEB.

On this topic, investors should probably avoid using these two funds as tax loss harvesting substitutes for one another since they would likely be considered “substantially identical.”

Tradability

VTEAX does have a stated minimum initial purchase of $3,000, so that may be a factor for some investors looking to initiate a position. The minimum purchase size for VTEB is typically one share, although fractional shares are becoming more common.

Investors can trade ETFs intraday, as well as in the pre-market and after-hours trading sessions. Investors can only buy/sell mutual funds once per day. This is not necessarily a major factor for long-term investors however.

Final Thoughts: VTEAX vs VTEB

VTEAX and VTEB are literally the same portfolio. However, I personally shy away from fixed-income ETFs due to their tendency to trade below NAV during episodes of extreme volatility. If two options provide the same risk and return, but one does not have periodic blowups then I’ll go with that one. Of course, there are other factors to consider (such as the above).

VHCIX vs VHT

By / Fund Comparison

The Vanguard Health Care Index Fund (Admiral Shares) (symbol VHCIX) and the Vanguard Health Care ETF (symbol VHT) are two of the largest and most popular healthcare sector index funds. Some compare VHCIX vs VHT not realizing that they are just two different share classes of the same portfolio.

A quick reminder that this site does NOT provide investment recommendations. Fund comparisons (such as this one) are not conducted to identify the “best” fund (since that will vary from investor to investor based on investor-specific factors). Rather, these fund comparison posts are designed to identify and distinguish between the fund details that matter versus the ones that don’t.

The Short Answer

VHCIX and VHT are different share classes of the same portfolio, which is made possible by Vanguard’s ETF share class structure. The decision to buy one or the other depends on investor-specific factors (some of which are listed below).

The Longer Answer

Vanguard ETFs are structured as share classes of their mutual funds. This is a patented structure that is scheduled to expire in 2023, so we may see this structure more frequently in the near future. In other words, VHCIX and VHT are not two funds pursuing an identical strategy; they are the same fund!

Historical Performance: VHCIX vs VHT

VHT was launched on January 26, 2004, while VHCIX was launched a few weeks later on February 5, 2004. Since that time, performance has been nearly identical to VHCIX: 10.52% vs 10.55% annually. Despite changes in fees and expenses over this time period, there is only about a three percent difference in cumulative performance since inception! Looking at the chart of VHCIX vs VHT below, it is obvious that they are identical.

Differences Between VHCIX and VHT

Since the two funds are actually two share classes of the same fund, I will skip the usual comparisons here. The geographic exposures, sector weights, market cap coverage so on is identical because the two funds are shares in the same portfolio. There are some resources on the internet indicating otherwise, but these are incorrect.

Factors to Consider

Transaction Costs

ETFs are free to trade at many brokers and custodians, including Vanguard. However, many brokers and custodians still charge commissions and/or transaction fees to buy/sell mutual funds. To my knowledge, Vanguard does not participate in the pay-to-play arrangements that would allow their mutual funds to trade for free on many platforms. So if an investor account is at Vanguard, it is free to trade VHCIX or VHT. However, only VHT is free to trade in non-Vanguard accounts.

There is a bid-ask spread when trading ETFs, but this spread is typically less than .04% for VHT and individual investor trades will not generally be large enough to “move” the market. In the case of VHT, individual investors should not have a problem trading.

Tax Efficiency & Capital Gain Distributions

ETFs are typically more tax-efficient than mutual funds, due to their ability to avoid realizing capital gains through like-kind redemptions (a process that is beyond the scope of this post). However, since Vanguard ETFs are a share class of their mutual funds, the mutual funds are able to benefit from this feature of the ETF. In other words, VHT is able to extend its tax benefits to VHCIX. A more in-depth explanation of Vanguard mutual fund tax-efficiency can be found here.

VHCIX has never paid a capital gain distribution! I noticed some posts on the internet saying that VHT is more tax-efficient than VHCIX, but this incorrect as neither fund has ever made a capital gains distribution.

Tax Loss Harvesting

My personal preference is to keep a portfolio entirely mutual funds or entirely ETFs, due to the mechanics of settlement during tax loss harvesting. If an ETF has declined in value and an investor sells it, the trade and cash proceeds will not settle for two business days (T+2). That investor may want to “replace” the sold ETF immediately and attempt to buy another ETF or mutual fund simultaneously.

However, mutual funds settle on T+1 basis, so cash for the mutual purchase would be due in one business day (which is one day earlier than the cash from the ETF sale is received). This can obviously cause problems and (even though this issue can be addressed with careful planning) I find it easier to keep accounts invested in similar vehicles. In this case, if a portfolio is all mutual funds, I might lean more towards VHCIX. If all ETFs, I might lean more towards VHT.

On this topic, investors should probably avoid using these two funds as tax loss harvesting substitutes for one another since they would likely be considered “substantially identical.”

Tradability

VHCIX does have a stated minimum initial purchase of $100,000, so that may be a factor for some investors looking to initiate a position. The minimum purchase size for VHT is typically one share, although fractional shares are becoming more common.

Investors can trade ETFs intraday, as well as in the pre-market and after-hours trading sessions. Investors can only buy/sell mutual funds once per day. This is not necessarily a major factor for long-term investors however.

Final Thoughts: VHCIX vs VHT

VHCIX and VHT are literally the same. However, investors should consider the above factors when deciding which one is best for them.

Those looking for other health care ETFs may want to read my posts comparing VHT and XLV (State Street’s health care ETF) or VHT vs FHLC (Fidelity’s health care ETF)

VSIAX vs VBR

By / Fund Comparison

The Vanguard Small-Cap Value Index Fund (Admiral Shares) (symbol VSIAX) and the Vanguard Small-Cap Value ETF (symbol VBR) are two of the largest and most popular small-cap index funds. Some compare VSIAX vs VBR not realizing that they are just two different share classes of the same portfolio.

A quick reminder that this site does NOT provide investment recommendations.

The Short Answer

VSIAX and VBR are different share classes of the same portfolio. The decision to buy one or the other depends on investor-specific factors (some of which are listed below).

The Longer Answer

Vanguard ETFs are structured as share classes of their mutual funds. This is a patented structure that is scheduled to expire in 2023, so we may see this structure more frequently in the near future. In other words, VSIAX and VBR are not two funds pursuing an identical strategy; they are the same fund!

Historical Performance: VSIAX vs VBR

VBR was launched on January 26, 2004, while VSIAX was launched a few years later on September 27, 2011. Since that time, performance has been identical: both funds have returned 12.38% annually! Despite changes in fees and expenses over this time period, there has only been about a 30 basis point difference in cumulative performance since inception! Looking at the chart of VSIAX vs VBR below, it is obvious that they are identical.

Differences Between VSIAX and VBR

Since the two funds are actually two share classes of the same fund, I will skip the usual comparisons here. The geographic exposures, sector weights, market cap coverage so on is identical because the two funds are shares in the same portfolio. There are some resources on the internet indicating otherwise, but these are incorrect.

Factors to Consider

Transaction Costs

ETFs are free to trade at many brokers and custodians, including Vanguard. However, many brokers and custodians still charge commissions and/or transaction fees to buy/sell mutual funds. To my knowledge, Vanguard does not participate in the pay-to-play arrangements that would allow their mutual funds to trade for free on many platforms. So if an investor account is at Vanguard, it is free to trade VSIAX or VBR. However, only VBR is free to trade in non-Vanguard accounts.

There is a bid-ask spread when trading ETFs, but this spread is typically less than .06% for VBR and individual investor trades will not generally be large enough to “move” the market. In the case of VBR, individual investors should not have a problem trading. Interestingly, the bid-ask spread of VBR is more than the annualized performance difference of VSIAX vs VBR.

Tax Efficiency & Capital Gain Distributions

ETFs are typically more tax-efficient than mutual funds, due to their ability to avoid realizing capital gains through like-kind redemptions (a process that is beyond the scope of this post). However, since Vanguard ETFs are a share class of their mutual funds, the mutual funds are able to benefit from this feature of the ETF. In other words, VBR is able to extend its tax benefits to VSIAX.

VSIAX paid a capital gain distribution in 2000, but has not made any since then (nor do I expect it to make any in the future due to the existence of VBR). I noticed some posts on the internet saying that VBR is more tax-efficient than VSIAX, but this incorrect as neither fund has ever made a capital gains distribution.

Tax Loss Harvesting

My personal preference is to keep a portfolio entirely mutual funds or entirely ETFs, due to the mechanics of settlement during tax loss harvesting. If an ETF has declined in value and an investor sells it, the trade and cash proceeds will not settle for two business days (T+2). That investor may want to “replace” the sold ETF immediately and attempt to buy another ETF or mutual fund simultaneously.

However, mutual funds settle on T+1 basis, so cash for the mutual purchase would be due in one business day (which is one day earlier than the cash from the ETF sale is received). This can obviously cause problems and (even though this issue can be addressed with careful planning) I find it easier to keep accounts invested in similar vehicles. In this case, if a portfolio is all mutual funds, I might lean more towards VSIAX. If all ETFs, I might lean more towards VBR.

On this topic, investors should probably avoid using these two funds as tax loss harvesting substitutes for one another since they would likely be considered “substantially identical.”

Tradability

VSIAX does have a stated minimum initial purchase of $3,000, so that may be a factor for some investors looking to initiate a position. The minimum purchase size for VBR is typically one share, although fractional shares are becoming more common.

Investors can trade ETFs intraday, as well as in the pre-market and after-hours trading sessions. Investors can only buy/sell mutual funds once per day. This is not necessarily a major factor for long-term investors however.

Final Thoughts: VSIAX vs VBR

VSIAX and VBR are literally the same. However, investors should consider the above factors when deciding which one is best for them.

Further Reading

Investors who are interested in the Vanguard’s non-value small-cap funds should read our comparison of VVIAX vs VTV.

TVPI vs MOIC

By / Alternative Investments

MOIC and TVPI are two popular performance metrics, especially within “alternative” investment asset classes such as real estate, private equity, and venture capital. Both are relatively easy to calculate and provide the context needed to understand performance beyond internal rates of return (or IRR, which is the default reporting metric for many private investments.

However, TVPI and MOIC are not the same. Continue reading to learn how to differentiate between TVPI vs MOIC.

MOIC

MOIC Definition

MOIC stands for Multiple On Invested Capital. It expresses returns as a multiple of investment. MOIC is typically quoted on a gross basis (so before expenses such as fees are deducted and taken into account).

MOIC Formula

Mathematically, MOIC is expressed as an investment’s value (both realized and unrealized) divided by the amount invested.

MOIC Example

Let’s assume an investor purchases a building for $10 million. Over the next few years, the investor receives $2 million of distributions and the building appreciates in value to $13 million. In this case, the total realized value is $2 million and the total unrealized value is $13 million. The total cost was $10 million. So the MOIC would be 1.5x.

MOIC Calculation

In the above example, we get 1.5x by adding $2 million and $13 million and then dividing by $10 million.

TVPI

TVPI Definition

TVPI stands for Total Value to Paid In. It expressed return as a multiple of “paid-in capital.” Paid-in capital is the money that an investor invests (regardless of how much is actually invested), so TVPI is often used to measure the performance of fund investments. TVPI can be quoted on a gross or net of fees basis.

TVPI Formula

TVPI Example

Let’s assume an investor buys into a fund that buys the above building. The investor contributes $11 million. $1 million dollars goes towards fund expenses and fees. The investor receives $1.5 million of distributions and expects to receive $12.5 million from the sale of the building (after all expenses and fees are paid). In this case, the TVPI is 1.27x.

TVPI Calculation

In the above example, we get 1.27x by adding $1.5 million and $12.5 million and then dividing by $11 million.

TVPI vs MOIC: Differences

Although MOIC and TVPI appear quite similar, the main differences between the two are:

  • MOIC is generally:
    • Quoted on a gross basis
    • Applicable to an investment
  • TVPI is generally:
    • Quoted on a gross or net basis
    • Applicable to an investor

Despite the differences, both metrics are helpful to use when evaluating IRR. Read our posts on MOIC vs IRR or TVPI vs IRR to learn more.

The Importance of MOIC and TVPI

MOIC and TVPI occupy an important place in investing in that they are widely-used multiple-based metrics. The other common metric in private market investing is internal rate of return (IRR). Both multiple-based and IRR-based returns have strengths and weaknesses, but neither should be used in isolation. Investors wanting to understand performance should be evaluating both multiples and IRRs.

Unfortunately, many investment managers and funds only advertise IRRs (and sometimes only gross IRRs!). At best, its an non-intuitive metric that does not paint a full picture by itself. At worst, it is used to obscure low investment returns on a multiple basis. Both MOIC and TVPI are valuable tools for investors evaluating investments.

VGSLX vs VNQ

By / Fund Comparison

The Vanguard Real Estate Index Fund (Admiral Shares) (symbol VGSLX) and the Vanguard Real Estate ETF (symbol VNQ) are two of the largest and most popular REIT index funds. Some compare VGSLX vs VNQ not realizing that they are just two different share classes of the same portfolio.

A quick reminder that this site does NOT provide investment recommendations.

The Short Answer

VGSLX and VNQ are different share classes of the same portfolio. The decision to buy one or the other depends on investor-specific factors (some of which are listed below).

The Longer Answer

Vanguard ETFs are structured as share classes of their mutual funds. This is a patented structure that is scheduled to expire in 2023, so we may see this structure more frequently in the near future. In other words, VGSLX and VNQ are not two funds pursuing an identical strategy; they are the same fund!

Historical Performance: VGSLX vs VNQ

VGSLX was launched on November 12, 2001, while VNQ was launched a few years later on September 23, 2004. Since that time, performance has been identical: 7.72% vs 7.73% annually! Despite changes in fees and expenses over this time period, there has been less than a 1% difference in cumulative performance since inception! Looking at the chart of VGSLX vs VNQ below, it is obvious that they are identical.

Differences Between VGSLX and VNQ

Since the two funds are actually two share classes of the same fund, I will skip the usual comparisons here. The geographic exposures, sector weights, market cap coverage so on is identical because the two funds are shares in the same portfolio. There are some resources on the internet indicating otherwise, but these are incorrect.

Factors to Consider

Transaction Costs

ETFs are free to trade at many brokers and custodians, including Vanguard. However, many brokers and custodians still charge commissions and/or transaction fees to buy/sell mutual funds. To my knowledge, Vanguard does not participate in the pay-to-play arrangements that would allow their mutual funds to trade for free on many platforms. So if an investor account is at Vanguard, it is free to trade VGSLX or VNQ. However, only VNQ is free to trade in non-Vanguard accounts.

There is a bid-ask spread when trading ETFs, but this spread is typically less than .01% for VNQ and individual investor trades will not generally be large enough to “move” the market. In the case of VNQ, individual investors should not have a problem trading. Interestingly, the bid-ask spread of VNQ is more than the annualized performance difference of VGSLX vs VNQ.

Tax Efficiency & Capital Gain Distributions

ETFs are typically more tax-efficient than mutual funds, due to their ability to avoid realizing capital gains through like-kind redemptions (a process that is beyond the scope of this post). However, since Vanguard ETFs are a share class of their mutual funds, the mutual funds are able to benefit from this feature of the ETF. In other words, VNQ is able to extend its tax benefits to VGSLX.

Both funds have made capital gain distributions in the past, but neither has made any since 2006. I noticed some posts on the internet saying that VNQ is more tax-efficient than VGSLX, but this incorrect as neither fund has ever made a capital gains distribution.

Tax Loss Harvesting

My personal preference is to keep a portfolio entirely mutual funds or entirely ETFs, due to the mechanics of settlement during tax loss harvesting. If an ETF has declined in value and an investor sells it, the trade and cash proceeds will not settle for two business days (T+2). That investor may want to “replace” the sold ETF immediately and attempt to buy another ETF or mutual fund simultaneously.

However, mutual funds settle on T+1 basis, so cash for the mutual purchase would be due in one business day (which is one day earlier than the cash from the ETF sale is received). This can obviously cause problems and (even though this issue can be addressed with careful planning) I find it easier to keep accounts invested in similar vehicles. In this case, if a portfolio is all mutual funds, I might lean more towards VGSLX. If all ETFs, I might lean more towards VNQ.

On this topic, investors should probably avoid using these two funds as tax loss harvesting substitutes for one another since they would likely be considered “substantially identical.”

Tradability

VGSLX does have a stated minimum initial purchase of $3,000, so that may be a factor for some investors looking to initiate a position. The minimum purchase size for VNQ is typically one share, although fractional shares are becoming more common.

Investors can trade ETFs intraday, as well as in the pre-market and after-hours trading sessions. Investors can only buy/sell mutual funds once per day. This is not necessarily a major factor for long-term investors however.

Final Thoughts: VGSLX vs VNQ

VGSLX and VNQ are literally the same. However, investors should consider the above factors when deciding which one is best for them.

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