Vanguard Shakes Up Index Business

Vanguard, the world’s biggest mutual fund company, has decided to move away from some MSCI indices over the next several months in favour of benchmarks created by FTSE. The firm said its move was motivated by lower index licensing costs and will involve the US$67 billion Vanguard MSCI Emerging Markets ETF (NYSEArca: VWO), the world’s largest tracker of developing market stocks.

Vanguard’s announcement sent MSCI shares down 27 percent in New York trading on Tuesday.

Vanguard’s switch affects six international equity funds that had total assets of US$170 billion as of August 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 provider 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 major difference between the two index benchmarks 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.

In its own press release, Vanguard said that in addition to the six international benchmarks moving to FTSE indices, it also plans to switch indices on 16 US stock and balanced index funds to benchmarks developed by the University of Chicago’s Center for Research in Security Prices (CRSP)—a provider of historical market data. The existing indices on these US-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 US$350 billion total amount that’s benchmarked to the 22 funds affected by the switch.

“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.

The Vanguard-FTSE agreement substantially expands a pre-existing relationship between the two companies. Vanguard currently uses FTSE benchmarks on more than 20 index portfolios around the world, with total assets of US$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 US$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.”

Changing Indices

Several of Vanguard’s largest and most widely held US-based index funds will change their benchmarks, including:

Vanguard Total Stock Market Index Fund and ETF (NYSEArca: VTI), which will move from the MSCI US 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.
Vanguard’s Sauter said that VWO’s temporary “transition” index will have an initial allocation to South Korea that will be trimmed by 4 percent each week for a 25-week period.

VWO: Different But The Same

The difference in weightings between MSCI’s and FTSE’s emerging markets is primarily a result of differing views on the development status of the South-East Asian nation.

“We classify South Korea as a developed country,” said Jill Mathers, a FTSE spokeswoman in New York.

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, but FTSE ties just under 19 percent of the portfolio to the sector, while MSCI had as much as a quarter of the mix linked to financial names as of the end of August.

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.

iShares Alone

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 means the long-standing rivalry between Vanguard’s fund and the US$37 billion iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM), both of which have historically been linked to the same MSCI index, will now be less acute.

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 indices—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.


Apart from how all this affects MSCI and iShares EEM, it’s pretty clear that FTSE is coming out a big winner.

It had to serve up a less expensive package than MSCI, but FTSE radically expanded its footprint in the US$1.3 trillion US 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 (NYSEArca: IFSM), $27.4 million
Schwab FTSE International Equity ETF (NYSEArca: SCHF), $839.8 million
Schwab FTSE Developed Small Cap Equity ETF (NYSEArca: SCHC), $167.8 million
Schwab FTSE All Emerging Market Equity ETF (NYSEArca: SCHE), $547.2 million
The fact that VWO will soon be sharing indices 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, which left the San Francisco-based company’s ETFs with the lowest expense ratios in the US, 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.

  • Luke Handt

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