Vanguard, the world's biggest mutual fund company, has decided
to segue away from some MSCI indexes over the next several months
in favor of benchmarks created by FTSE. The move was motivated in
part by lower index licensing costs and will involve its $67
billion Vanguard MSCI Emerging Markets ETF (NYSEArca:VWO).
Vanguard's switch affects six international equity funds that
had total assets of $170 billion as of Aug. 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 firm with the deepest ties to
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 huge difference is the absence of South Korea from
the FTSE index, while the MSCI index weights the country at around
"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. It's tempting to view Vanguard's move as a riposte to
the Charles Schwab fee cuts the company did last month on its
15 ETFs, though Vanguard officials downplayed this.
In its own press release, Vanguard said that in addition to the
six international benchmarks moving to FTSE indexes, it also plans
to switch indexes on 16 U.S. stock and balanced index funds to
benchmarks developed by the University of Chicago's Center for
Research in Security Prices (CRSP)-a leading provider of
research-quality, historical market data and returns. The existing
indexes on these U.S.-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 $537 billion total amount that's benchmarked to
the 22 funds affected by the switch. That's the $170 billion
associated with the FTSE move and $367 billion linked to the CRSP
"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
Sauter noted that the transition wouldn't begin for several
months and wouldn't be completed until well into 2013.
MSCI, shedding additional light on the financial piece of the
tale, said annual operating income it currently derives from the 22
funds in question totals about $24 million.
"The impact to reported financial results is expected to start
in January 2013 as the funds are transitioned," the company said
Tuesday in a press release.
Again, MSCI said it believes the transition process will begin
early next year.
On the other side of the fence, the Vanguard-FTSE agreement
builds on a pre-existing relationship between Valley Forge,
Pa.-based Vanguard and London-based FTSE. Vanguard currently uses
FTSE benchmarks on more than 20 index portfolios around the world
with total assets of $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
$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.'
Several of Vanguard's largest and most widely held index funds
will change their benchmarks, including:
- Vanguard Total Stock Market Index Fund and ETF
(NYSEArca:VTI), which will move from the MSCI U.S Broad Market
Index to the CRSP US Total Market Index
- Vanguard Emerging Markets Stock Index Fund and ETF (
), 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.
The benchmarks for Vanguard Target Retirement Funds,
LifeStrategy Funds, Managed Payout Funds, and other funds-of-funds
will also change.
For these funds-of-funds, the MSCI All Country World ex USA
Investable Market Index and MSCI US Broad Market Index components
of the composite indexes will be replaced by the FTSE Global All
Cap ex US Index and the CRSP US Total Market Index.
Asset allocations for the funds-of-funds will not change.
Again, Sauter said the transition hasn't yet begun, and won't be
done until sometime next year.
But he did say that VWO's temporary index will have an
allocation to South Korea that Vanguard's portfolio management team
will trim the Korea position from the portfolio by 4 percent each
week for a 25-week period.
VWO:Different But The Same
The Korea difference is substantial and relates to how FTSE
views the emerging markets investment universe.
"We classify South Korea as a developed country," said Jill
Mathers, a FTSE spokeswoman in New York.
"Obviously not having companies like Hyundai, Kia and Samsung is
a big difference," she added, referring to three South Korean
companies that are at the center of the country's modern, high-tech
"We do think that South Korea is a developed country," Sauter
While Korea's absence from the FTSE index is big, it's not clear
that returns would be all that different given correlations of
returns between different rapidly growing countries, as
IndexUniverse ETF Analyst Paul Baiocchi pointed out in a blog
earlier this year. If Korea made a positive difference in the past
decade, it's not at all clear it will keep making a difference.
In any case, apart from the Korea difference, VWO's new
benchmark isn't all that different from the MSCI index it has been
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 at about a quarter of the
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
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 puts an end to a
long-standing rivalry between Vanguard's fund and the $37 billion
iShares MSCI Emerging Markets Index Fund (NYSEArca:EEM), both of
which have been linked to the same MSCI index.
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
indexes-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
IndexUniverse Director of Research Dave Nadig said he sees
potential for iShares, particularly as it relates to institutional
'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.
SCHE, The New EEM
Apart from how all this affects MSCI and iShares EEM, it's
pretty clear that FTSE is coming out a big winner.
Sure it had to serve up a less expensive package than MSCI did,
but it radically expanded its footprint in the $1.3 trillion U.S.
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
- Schwab FTSE Developed Small Cap Equity ETF (NYSEArca:SCHC),
- Schwab FTSE All Emerging Market Equity ETF (NYSEArca:SCHE),
The fact that VWO will soon be sharing indexes 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
Sauter dismissed the idea that Vanguard's announcement was in
any way meant to be a response to Schwab's price cuts last month
that left the San Francisco-based company's ETFs with the lowest
expense ratios in the U.S., and said the timing was purely
"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
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
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