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Portfolio > Mutual Funds

Vanguard Switching Indexes

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To cut costs for investors, Vanguard plans to transition 22 funds, many of which have an ETF share class, to new indexes starting in 2013, the fund giant said in early October. The changes entail moving six international stock index funds and 16 U.S. stock and balanced index funds with about $537 billion in assets from MSCI benchmarks to those constructed by FTSE and the University of Chicago’s Center for Research in Security Prices (CRSP).

“The indexes from FTSE and CRSP are well constructed, offer comprehensive coverage of their respective markets, and meet Vanguard’s ‘best practice’ standards for market benchmarks,” said Vanguard Chief Investment Officer Gus Sauter, in a press release. “Equally important, and with our clients’ best interests in mind, we negotiated licensing agreements for these benchmarks that we expect will enable us to deliver significant value to our index fund and ETF shareholders and lower expense ratios over time.”

According to the fund giant, index licensing fees have represented a growing portion of expenses paid by investors to own index funds and ETFs. Vanguard’s long-term agreements with FTSE and CRSP should “provide cost certainty going forward with these two index providers,” Sauter says.

The move makes sense for both investors and for Vanguard, experts note. “Vanguard is the third-largest ETF provider, after iShares and State Street,” said Todd Rosenbluth, and ETF analyst with S&P Capital IQ, in an interview. “It is gaining market share this year–and it is the cheapest of the three. By getting even cheaper, it has the potential to gain more market share.”

(In September, Charles Schwab announced it was cutting operating expense ratios on its proprietary ETFs.)

Six Vanguard international index funds with total assets of $170 billion will transition to benchmarks in the FTSE Global Equity Index Series, including the $67 billion Vanguard Emerging Markets Stock Index Fund. This fund’s ETF shares (VWO) are currently the world’s largest emerging markets ETF.

Sixteen Vanguard stock and balanced index funds, with total assets of $367 billion, will move to the CRSP benchmarks, including Vanguard’s largest index fund, the $197-billion Vanguard Total Stock Market Index Fund, which has ETF shares (VTI).

No changes are planned for Vanguard U.S. stock index funds that track Russell and Standard and Poor’s benchmarks, or the 11 Vanguard sector equity funds that have MSCI benchmarks.

The benchmarks for Vanguard’s Target Retirement, LifeStrategy, and Managed Payout Funds and other funds of funds will also change, the company says, thought the asset allocations of the funds will not. The MSCI All Country World ex USA Investable Market Index and MSCI US Broad Market Index components will be replaced by the FTSE Global All Cap ex US Index and CRSP US Total Market Index.

The transition to new benchmarks is not expected to result in capital gains, but it will require some turnover of holdings and result in transaction cost, which Vanguard says it will seek to “minimize.”

 “Vanguard is the mutual fund industry’s only client-owned firm that manages its funds and ETFs at cost,” said Sauter, who is retiring at year end. “Our structure, along with our ongoing commitment to keep operating costs at the lowest reasonable levels, leads to low expenses that are enduring in nature.”

According to Rosenbluth, the changes should bring down expense ratios. However, the impact of new benchmarks to portfolio holdings and performance is unknown.

“We could see lower risk or higher risk stocks get added to the portfolios,” the analyst noted. CRSP, for instance, has different rules about growth vs. value stocks and small-, mid- and large-cap stocks from MSCI. “We won’t know what the resulting portfolios will look like until the changes are implemented,” explained Rosenbluth.


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