Vanguard, the world’s biggest mutual fund company, has decided to segue away from some MSCI indexes over the next several months in favor of benchmarks created by FTSE. The move was motivated in part by lower index licensing costs and will involve its $67 billion Vanguard MSCI Emerging Markets ETF (VWO).
Vanguard’s switch affects six international equity funds that had total assets of $170 billion as of Aug. 31, FTSE said today in a press release, noting the transaction was the largest ever international index-provider switch. The switch leaves iShares, the world’s biggest ETF firm, as the ETF firm with the deepest ties to MSCI.
The six funds will change to benchmarks in the FTSE Global Equity Index Series, replacing MSCI, and VWO and the index mutual fund of which it is part will be based on the FTSE Emerging Index, FTSE said. One huge difference is the absence of South Korea from the FTSE index, while the MSCI index weights the country at around 15 percent.
“This was a situation where we could line up some cost savings down the road for investors and still have a great benchmark provider,” Vanguard spokeswoman Linda Wolohan said today in an interview. It’s tempting to view Vanguard’s move as a riposte to the Charles Schwab fee cuts the company did last month on its 15 ETFs , though Vanguard officials downplayed this.
In its own press release, Vanguard said that in addition to the six international benchmarks moving to FTSE indexes, it also plans to switch indexes on 16 U.S. stock and balanced index funds to benchmarks developed by the University of Chicago's Center for Research in Security Prices (CRSP)—a leading provider of research-quality, historical market data and returns. The existing indexes on these U.S.-focused funds are also provided by MSCI.
Vanguard Chief Investment Officer Gus Sauter estimated that cost savings to investors would likely climb to the “millions” of dollars, given the $537 billion total amount that’s benchmarked to the 22 funds affected by the switch. That's the $170 billion associated with the FTSE move and $367 billion linked to the CRSP indexes.
“The transition from the funds' current benchmarks, which are maintained by MSCI, is expected to be completed over a number of months and will be staggered,” Vanguard said in its prepared statement.
Sauter noted that the transition wouldn’t begin for several months and wouldn’t be completed until well into 2013.
MSCI, shedding additional light on the financial piece of the tale, said annual operating income it currently derives from the 22 funds in question totals about $24 million.
“The impact to reported financial results is expected to start in January 2013 as the funds are transitioned,” the company said Tuesday in a press release.
Again, MSCI said it believes the transition process will begin early next year.
On the other side of the fence, the Vanguard-FTSE agreement builds on a pre-existing relationship between Valley Forge, Pa.-based Vanguard and London-based FTSE. Vanguard currently uses FTSE benchmarks on more than 20 index portfolios around the world with total assets of $26 billion.
One executive at a European exchange-traded fund provider, who preferred to remain anonymous, commented:"Given the size of VWO, even a 1 basis point cut in annual index licensing fees represents $7 million in savings for the fund and its investors, and the cut may well have been more than that in practice. It's also good to see increasing competition between index providers, who have often behaved as an oligopoly when licensing their indices."
Several of Vanguard's largest and most widely held index funds will change their benchmarks, including:
- Vanguard Total Stock Market Index Fund and ETF (VTI), which will move from the MSCI U.S Broad Market Index to the CRSP US Total Market Index
- Vanguard Emerging Markets Stock Index Fund and ETF (VWO), which will move from the MSCI Emerging Markets Index to the FTSE Emerging Index. To ease the transition of portfolio holdings, the change will occur in two phases with the fund moving temporarily to the FTSE Emerging Transition Index before shifting to the FTSE Emerging Index.
The benchmarks for Vanguard Target Retirement Funds, LifeStrategy Funds, Managed Payout Funds, and other funds-of-funds will also change.
For these funds-of-funds, the MSCI All Country World ex USA Investable Market Index and MSCI US Broad Market Index components of the composite indexes will be replaced by the FTSE Global All Cap ex US Index and the CRSP US Total Market Index.
Asset allocations for the funds-of-funds will not change.
Again, Sauter said the transition hasn’t yet begun, and won’t be done until sometime next year.
But he did say that VWO’s temporary index will have an allocation to South Korea that Vanguard’s portfolio management team will trim the Korea position from the portfolio by 4 percent each week for a 25-week period.
VWO:Different But The Same
The Korea difference is substantial and relates to how FTSE views the emerging markets investment universe.
“We classify South Korea as a developed country,” said Jill Mathers, a FTSE spokeswoman in New York.
“Obviously not having companies like Hyundai, Kia and Samsung is a big difference,” she added, referring to three South Korean companies that are at the center of the country’s modern, high-tech economy.
“We do think that South Korea is a developed country,” Sauter told IndexUniverse.
While Korea’s absence from the FTSE index is big, it’s not clear that returns would be all that different given correlations of returns between different rapidly growing countries, as IndexUniverse ETF Analyst Paul Baiocchi pointed out in a blog earlier this year. If Korea made a positive difference in the past decade, it's not at all clear it will keep making a difference.
In any case, apart from the Korea difference, VWO’s new benchmark isn’t all that different from the MSCI index it has been using.
The FTSE Emerging Index is a free-float-weighted benchmark that comprises some 793 securities in 23 countries, according to information on the company’s website.
Like its MSCI counterpart, both benchmarks hold financials as their top sector allocation at about a quarter of the portfolio.
While their country exposures are also similar, FTSE’s is broader, as it includes allocations to Pakistan and the United Arab Emirates—at 0.12 percent and 0.34 percent weightings—two countries not found in the MSCI Emerging Markets Index.
Still, both indexes hold China as their single largest country allocation at about 17 percent of the total basket. Their second largest country allocation is Brazil, but in FTSE it represents 16 percent of the total compared with 13 percent in MSCI’s Emerging Markets Index.
Vanguard’s move away from MSCI leaves San Francisco-based iShares with some of the deepest ties to MSCI in the ETF industry. And it looks like it wants to deepen them.
If nothing else, a new benchmark for VWO puts an end to a long-standing rivalry between Vanguard’s fund and the $37 billion iShares MSCI Emerging Markets Index Fund (EEM), both of which have been linked to the same MSCI index.
EEM, the older of the two ETFs, was also the largest until 2011, when VWO managed to get the upper hand in terms of assets under management thanks to a cheaper price tag and a better record tracking its index.
Still, iShares may be seeing this index switch as an opportunity to regain some momentum.
“MSCI is the gold standard of global and international equity indexes—the near universal choice of professional investors,” Mark Wiedman, global head of iShares said in a prepared statement. “We plan to deepen our partnership with MSCI to help deliver the highest quality products and portfolio construction to our clients.”
IndexUniverse Director of Research Dave Nadig said he sees potential for iShares, particularly as it relates to institutional investors.
"This could be seen as a small salvo from Vanguard in the price war, as this likely lets them keep fees extremely low, or possibly even lower them more in the future,” Nadig said.
“However, iShares now becomes the only game in town for any investor or institution with either an MSCI mandate or an MSCI benchmark," he added.
SCHE, The New EEM
Apart from how all this affects MSCI and iShares EEM, it’s pretty clear that FTSE is coming out a big winner.
Sure it had to serve up a less expensive package than MSCI did, but it radically expanded its footprint in the $1.3 trillion U.S. ETF market.
Until today announcement, FTSE was the index provider for only four broad size and style funds outside of Vanguard. Those funds and their assets are:
- iShares FTSE Developed Small Cap ex-North America (IFSM), $27.4 million
- Schwab FTSE International Equity ETF (SCHF), $839.8 million
- Schwab FTSE Developed Small Cap Equity ETF (SCHC), $167.8 million
- Schwab FTSE All Emerging Market Equity ETF (SCHE), $547.2 million
The fact that VWO will soon be sharing indexes with Schwab’s SCHE puts in sharp focus the idea of what Nadig and others in the ETF industry are calling a “price war” between the two low-cost providers.
Sauter dismissed the idea that Vanguard’s announcement was in any way meant to be a response to Schwab’s price cuts last month that left the San Francisco-based company’s ETFs with the lowest expense ratios in the U.S., and said the timing was purely coincidental.
“Actually, [Schwab] wasn’t in the consideration, honestly,” Sauter said. “What we were trying to do, as we always do, is try to find value for our clients. And we found a way to add additional value.”
As things stand, SCHE is the cheaper of the two developing-market funds, with an annual expense ratio of 0.15 percent, or 15 basis points, compared with 20 basis points for VWO.
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