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Reversal Of Fortune In EEM-VWO Asset War

Spencer Bogart

A month and a half after Vanguard shocked the indexing world by dropping MSCI as the benchmark provider for more than $500 billion worth of its funds, the dust is still settling.

It seems clear the change will truly reduce costs for Vanguard’s largely buy-and-hold investor base, but it could hurt Vanguard too, as institutional investors choose to stick with competing MSCI-tracking funds, notably from iShares.

Some asset flows along these lines caught my eye in the past week. The Vanguard MSCI Emerging Markets ETF (VWO), which will no longer have the same index as the iShares MSCI Emerging Markets Index Fund (EEM) sometime next year, suffered redemptions of more than $700 million, while EEM pulled in $850 million over the same period.

Flows:June to November

This reverses a trend of asset flows over the past few years that definitely favored VWO. There were early signs something might have been up late last month, as my colleague Carolyn Hill pointed out incipient signs of change; namely, that EEM was picking up fresh assets while VWO wasn’t .

Interestingly, the flow between the two powerhouse emerging markets funds is from the lower-expense-ratio VWO to the higher-expense-ratio EEM. That’s important, because VWO’s 20-basis-points-a-year price tag was one of its main attractions when compared with EEM’s cost of 67 basis points.

While that comparison was particularly salient when the funds shared indexes, there may now be more at play here than just expense ratios and MSCI vs. non-MSCI indexes. For one, EEM isn’t making any changes, and it’s known to be one of the more liquid ETFs, which may trump Vanguard’s low-fee advantage.


To put this tale of two worlds in perspective, over the past week, EEM accumulated more assets than any other ETF, whereas VWO had the second-largest asset outflow of any ETF.

As I said, this is a striking reversal. From the start of the year to the date of Vanguard’s index-change announcement, 88 percent of the $13 billion-plus of inflows into the two funds went to VWO.

Of course, we can’t be certain that EEM’s inflows are a direct result of VWO’s outflows, but they’re definitely conspicuous. We could be witnessing a slow flow of MSCI-seeking assets from VWO to EEM in a zero-sum game, or we could be witnessing money that was previously sidelined going to work for EEM.



Either way, since the announcement, Vanguard’s VWO has yet to have a single day of significant inflows, whereas iShares’ EEM has seen eight days of noteworthy asset gathering, for an aggregate asset inflow of over $2 billion.

As my colleague and IndexUniverse Director of Research Dave Nadig noted , institutional investors may prefer funds that track MSCI indexes because of MSCI’s clean and transparent rules and long performance records.

The MSCI indexes also dovetail nicely into one another and have a presence on almost every major data service and analytical platform.

Aware that tracking error could cost them their jobs, institutional money managers may be hesitant to invest in a fund that tracks an index other than the one their performance is benchmarked against. Most often, that’s an MSCI index.

Lingering Uncertainty

The other element that could be driving assets toward EEM is the relative certainty that it offers in comparison to VWO.

Not only do investment managers sticking with Vanguard risk introducing tracking error relative to an MSCI index they are benchmarking against, they are grappling with additional uncertainty surrounding the change.

Vanguard also changed indexes on a total of 16 domestic funds to benchmarks created by the University of Chicago’s Center for Research in Security Prices (CRSP), and much of the data on the CRSP indexes are still unavailable.

Additionally, VWO will have a “transitional” index next year as it seeks to unwind a South Korea position of 15 percent of the $55 billion fund over a period of five months. The aim is to minimize how much the transition upsets investment markets, but Vanguard hasn’t been too specific about how it will all work out.

Could recent asset flows suggest this uncertainty may not sit well with money managers? It could be, and we’ll have to see if they continue, as Vanguard begins to implement its shift away from MSCI at the start of the year.

Time will tell how this plays out, and I’ll be watching it.

At the time this article was written, the author held no positions in the securities mentioned. Contact Spencer Bogart at sbogart@indexuniverse.com.


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