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.
Thanks for the article. I was just reading the article you tweeted this morning and was wondering what your opinion was.
For those you don’t follow you: http://t.co/yxvedYmj
@Sterling: I agree with the argument in the article in principle. That is, investors should be able to understand the indexes linked to their ETFs, and transparency is vital. But I don’t have any concerns that the CRSP indexes are going to be mysterious black boxes. CRSP is new to the index provider business, but it is a highly regarded research institution whose data are widely used by academics. We’ll keep an eye on things, but I trust Vanguard to look out for its investors’ interests.
I liked VCE because it had 100+ stocks. What can I do to keep that diversification?
I currently have VCE and XCS.
@JoeK: You could split your Canadian equity holding between VCE and XMD instead of using XCS.
Or you could look at ZCN as a core holding. It’s become a compelling option compared with VCE (too much large-cap) and XIC (more expensive).
The distributions seem to be higher for XIC right now than ZCN. Do you know if this will eventually change once the underlying index changes? I wonder if there is any way to know?
I will need to try to calculate if XMD will leave me with the same small cap % I want. There will be some double dipping with VCE and XMD although not as much as before.
I agree ZCN is worth a look.
I today still hold VCE as my core Canadian holding, but agree with the comments above that I’m not sure I like the diversity within being reduced, and especially the even greater exposure to financials. ZCN is starting to look a whole lot better to me lately.
BTW thanks as always for the great and informative post. I read about this in the news, and immediately checked here for a “reaction” to the changes – and lo, there it was already! It’s nice to have a site that offers this sort of stuff with the uniquely Canadian perspective.
@adam: ZCN just relaunched with its new index, so the distributions will take a while to sort out. There is no reason to expect any difference between XIC and ZCN going forward.
@Joe K: This post may help you sort things out:
@Danno: Thanks, glad if I could be of help.
A lot of investors, self included, are underweighting the EAFE because of Euro and China slowdowns. Putting hotter Korea into that mix “gradually” should help the Vanguard fund, but confuses the index allocation, I’m aware discussion of moving Korea from emerging to developed status has been “ongoing” but don’t like confusion between former equivalents VEA/EFA and VWO/EEM and that I bought my emerging mkt position in VWO on the basis of owning a lot of Korea in it. So now it’s transaction fees if I want to keep that 15% index exposure.
How come you recommend XIC over ZCN in your model portfolios when they track the same index but one is cheaper than the other? Is 12 basis points worth XIC’s past index tracking record?
In the past you have touched on new products that sound good but state you’ll wait to see how efficient the ETF tracks their index before moving on it. Is was this one of those cases and 3 years isn’t enough time yet? What is considered enough time to determine if the ETF is efficient in tracking its index or not?
@Joel: ZCN has only been tracking the S&P Composite for a few weeks:
I typically like to wait at least a year to see if the ETF can keep its tracking error low. In this case, given BMO’s good record in the past, I would have no hesitation switching to ZCN any time.
@CCP: my bad, their website says it started May 29, 2009 (http://www.etfs.bmo.com/bmo-etfs/glance?fundId=72048).
Could anybody comment on the difference between an ETF tracking a US index eg S&P 500 trading in USD compared to CAD apart from the costs related to currency conversion costs..thanks. Real Novice
@Larry: The Canadian-listed ETF will be cheaper and easier to trade. However, the Canadian-listed ETFs tracking foreign equities usually use currency hedging, which can causes a long-term drag on returns. In addition, if you hold the Canadian-listed ETF in a registered account you will pay a withholding tax on dividends. Some posts that may help:
Here’s another estimate on fees as proportion of fund costs from IndexUniverse – http://www.indexuniverse.com/sections/blog/14714-the-squeeze-on-index-fees.html
$24 million to MSCI for Vanguard on $537 billion in assets in total = 0.0045% on average per year. On VWO’s 0.20% MER that is 2.2% of costs. Quite puny. Even if Vanguard saves half with FTSE can it even move the MER to 0.19%?
I believe part of the issue was that MSCI was planning to increase its fees, so the difference is somewhat greater. That said, it does indeed still seem pretty small.
Can someone PLEASE tell me what’s happening with VXUS.US?
It’s a fairly large part of my Couch Potato portfolio and it just keeps flying South for me.
Anyone have any thoughts?
@Acme: VXUS is an index fund that tracks the global stock market, except the US. As the global markets go, so goes VXUS. In 2011 it did poorly, because markets around the world did poorly. But it’s up 15% over the last 12 months (in US dollars) because markets around the world have been strong. That’s the nature of index investing: you get exactly what the market gives.
Thanks for the reply. Am just wondering that if global markets are indeed up 15%, why then is my position on this ETF (VXUS), doing so poorly? Especially in light of the fact that it was a recomendation from Money Sense’s latest book?
Just wondering … and thank-you again.
@Acme: It all depends on when you bought it. If you bought it early in 2011 it will still be down today. If you bought it later in the year it will be up.
Remember that the model portfolio recommendations in my book and on this site are for the long term: think 10 years or more. There will always be periods where they will lose value, and these periods can last several years.
Will bear your advice in mind. Thanks for your comments and encouragement.
excuse my ignorance, but I’m trying to sort out something very basic. Does it mean that if you own stocks in the index fund VCE for example, the holdings within that index fund are going to change, but the value of the stock itself should remain at the same price, and the end small time investor (like myself) won’t notice the change?
@n00b: That’s right, the change will occur without any disruption. The net asset value of the fund will not change, nor will the share price. No need to take any action if you are a current unitholder.
Hi Dan, I’m in the midst of building my own spin on your couch potato method. For US equities, I was planning on exposure through VTI, but it appears there is one that is Canadian Hedged (VUS-above). Just wondering if you would so kindly go over the pro’s AND the con’s of hedging. I’ve read mainly that it can be a negative thing due to tracking errors, but what are the positives?
I am doing an annual review/rebalance with the handy excel spreadsheet that you provided earlier this year for my own and my wife’s RRSP. I have been reading this over and this index change does make me wonder how to add to my Canadian equity holdings when rebalancing. My Canadian equity holding is mainly in VCE. Given the VCE shift to large cap, would it make sense to buy XCS to broaden my exposure? The other option would be to start to buy XIC or CRQ, though I don’t like the idea of multiple ETFs for the same purpose.
I check your site regularly and it is always helpful. Happy New Year.
@Chris: The index change to VCE will be pretty minor. It’s a large-cap fund now, and the index change should not make a big difference in terms of exposure. If you’re comfortable holding VCE now I don’t see any compelling reason to switch strategies.