Vanguard has announced it is changing the benchmark indexes on four of its Canadian and 22 of its US ETFs, including some of its most popular funds.
Over the next several months, Vanguard will be stepping away from its relationship with MSCI, one of the world’s largest index providers, and entering new relationships with FTSE and CRSP. I’ll explain these acronyms in a moment, but first let’s have a look at the key funds that will be getting a new benchmark. The full list is available here.
|Canadian-listed ETF||New Index|
|Vanguard MSCI Canada (VCE)||FTSE Canada|
|Vanguard MSCI US Broad Market (VUS)||CRSP US Total Market|
|Vanguard MSCI EAFE (VEF)||FTSE Developed ex North America|
|Vanguard MSCI Emerging Markets (VEE)||FTSE Emerging Index|
|Vanguard Total Stock Market (VTI)||CRSP US Total Market|
|Vanguard Developed Markets (VEA)||FTSE Developed ex North America|
|Vanguard Emerging Markets Stock (VWO)||FTSE Emerging Index|
|Vanguard Total International Stock (VXUS)||FTSE Global All Cap ex US Index|
The new index providers may not be familiar to Canadians. FTSE (pronounced “footsie”) is a British firm best known for its FTSE 100, a widely used benchmark of large-cap stocks listed in London. The indexes they’re licensing to Vanguard will be very similar to the MSCI benchmarks used now. They’re all plain vanilla cap-weighted indexes with similar rules, so the performance of the funds should be substantially unchanged, with at least a couple of exceptions.
First, the new FTSE Canada Index (which will be the benchmark for VCE) includes only 77 stocks, down from 102 in the MSCI Canada Index. That will give VCE even more of a large-cap tilt than before: financials, for example, will make up about 36% of the new index, compared with 33% of the MSCI benchmark (based on August data). I’m disappointed they didn’t go in the opposite direction and expand the index to include more companies than the S&P/TSX Composite, though I recognize there are liquidity concerns with small-cap Canadian stocks.
Second, South Korea is currently the second-largest country in the MSCI Emerging Markets Index, with a weighting of about 15%. However, FTSE classifies South Korea as a developed market, so the country will be gradually removed from VWO and VEE and into VEA and VEF. If you hold both developed and emerging markets in your portfolio, this won;t make any material difference.
The new benchmark for VXUS—a fund I love for its incredibly broad coverage—will be the FTSE Global All Cap ex US, which includes about 5,300 stocks. That’s actually fewer than VXUS’s current index (the fund now holds almost 6,300 stocks), but it seems unlikely that will change its profile much.
CRSP and Clean
CRSP (pronounced “crisp”) is the Center for Research in Security Prices, a revered institution at the University of Chicago’s Booth School of Business, established in 1960. The historical data compiled at CRSP has been used by academics for decades and is the basis for the research of Fama and French. Vanguard commissioned the new indexes, and this is the first time CRSP benchmarks have been licensed to retail ETFs.
The most interesting feature of the CRSP indexes is a technique called “packeting,” which is designed to reduce turnover. Say for example a small-cap stock has risen sharply in value and has crossed the threshold to become a mid-cap stock. Rather than automatically moving the stock from one index to the other (which could trigger a capital gain), the CRSP methodology calls for 50% of the total holding to be placed in each index. This is similar to the techniques used by Dimensional Fund Advisors to keep transaction costs and taxes to a minimum.
Why the change?
Part of a fund’s MER is a licensing fee paid to the index provider. The ETF companies are tight-lipped about this, but my estimate is it amounts to perhaps 10% to 15% of the total management fee, depending on the popularity of the index and the size of the fund. According to IndexUniverse, MSCI “charges [a] premium price because, honestly, it can.” Doug Cronk also reported in June that MSCI was raising its fees and suggested index funds may soon pass those costs along to investors. Vanguard says it has secured long-term licensing deals with FTSE and CRSP at a favourable rate, which suggests they may lower the ETFs’ management fees in the future.
Vanguard has explained the transitions will take place over many months in order to keep transaction costs and tracking error as low as possible. All of the changes should be implemented by mid-2013. They also said they do not expect the funds to distribute any capital gains as a result of the turnover.
The new indexes (especially the CRSP benchmarks, which are fairly complex) may cause some confusion for investors. But overall I think this is good news, and more evidence that Vanguard is committed to being the cost leader in ETFs without sacrificing quality.