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InvestmentPulse

Important changes at Vanguard

October 16, 2012

Last week, the Vanguard Group announced it was changing the benchmarks for 22 US-listed exchange-traded funds (ETFs) and 4 of its Canadian-listed ETFs. Because all of these funds are index-based, their composition will undergo changes when the index switch occurs. Since PWL invests part of its client assets in Vanguard ETFs, these changes warrant an explanation.

What’s happening?
During the first half of 2013, Vanguard will switch from MSCI indices to CRSP indices for its US equity ETFs, and to FTSE indices for its non-US equity ETFs. A brief explanation of this alphabet soup of acronyms is given below.

Why is it happening?
Index companies charge index-fund managers licencing fees for using their services. MSCI is planning to increase its licencing fees. But since Vanguard basically operates at cost, standing pat would have forced it to increase its fees to investors. By changing index providers, Vanguard avoids this fee hike, and it even expects to reduce its (already rock-bottom) ETF fees over time.

What are the impacts?
Apart from keeping fees low, the benchmark change will have little impact on portfolios. While MSCI indices are extremely well-constructed, the same can be said of both CRSP and FTSE indices. The key advantage of MSCI’s indices over those of its two competitors is that they are widely used by the pension-fund industry; indeed, this popularity allows it to charge a price premium. But individual investors who are simply trying to grow their wealth don’t need that. On another note, Vanguard does not expect the index transition to trigger any taxable capital gains. On the Canadian ETF front, Vanguard’s Canadian Equity ETF will be less diversified after the change, with a decline from 102 to 77 stocks. This is the only negative impact we can find in the changeover.

Who is Vanguard?
Vanguard is the firm that popularized index investing for individuals. From a modest start in the 1970s, it has grown its assets under management to $1.7 trillion USD, making it the largest mutual-fund firm in the US. The firm is owned by its fund investors, and therefore, it charges fees that are equal to its operating costs. Vanguard’s reputation is second to none in terms of integrity and it is a dominant index-fund provider because of the precision with which it replicates its indices. Vanguard started listing ETFs in Canada in 2011.

Who is MSCI?
MSCI stands for Morgan Stanley Capital Indices. It has been a pioneer in measuring global stock-market returns since the late 1960s and is well-known for its rigorous methodologies. Because of these two qualities, it enjoys significant credibility within pension-fund circles. A former division of the investment bank Morgan Stanley, MSCI was spun-off as an independent public company in 2007.

Who is CRSP?
CRSP (pronounced “crisp”) stands for the Center for Research in Security Prices, a revered institution at the University of Chicago. Established in the late 1950s with a subsidy from Merrill Lynch, CRSP is the most complete database of US security prices dating back to 1926. Most major academic empirical studies of the US stock market have been done using CRSP data, including the famous works of Professors Eugene Fama and Kenneth French.

Who is FTSE?
FTSE (pronounced “footsie”) stands for Financial Times Stock Exchange. It is well-known for its FTSE 100 Index, the main benchmark for the London Stock Exchange. In recent decades, FTSE has expanded into measuring global stock returns, and it more recently gained visibility for pioneering innovative index methodologies. The new FTSE indices being adopted by Vanguard ETFs however are classic market-cap weighted indices.

Conclusion
Vanguard’s changes to its ETF benchmarks are necessary so it can continue to charge the lowest possible fees to investors. Apart from the reduced diversification of the Canadian Equity ETF, the changes are not expected to have any negative impact: they will result in no additional taxes and will maintain a portfolio-construction methodology that’s as rigorous as ever. We believe it’s a win for investors. 

 

Raymond Kerzérho

Chairman of the Investment Committee
and Director of Research
PWL Capital Inc.