January 31, 2013 4:37 pm

Vanguard benchmark switch under attack

Vanguard’s decision to scrap MSCI’s indices as the benchmarks for many of its largest index funds has come under further attack with S&P Capital IQ believing it will hurt investors.

The assertion comes as Vanguard, the US mutual fund group, today completed the migration of another five funds away from MSCI benchmarks.


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“If you own a handful of Vanguard funds you will be affected by benchmark changes this year. I doubt investors are aware what it [the switch] will mean,” said Todd Rosenbluth, a fund analyst at SP Capital IQ.

“What is in investors’ portfolios will be different and may detract from performance,” he added.

The US fund manager’s shift from MSCI benchmarks to cheaper FTSE and CRSP [the Center for Research in Security Prices] indices, involving 22 mutual funds and exchange traded funds with $537bn of assets, will in some cases affect portfolio holdings. The decision was made in October last year.

“There are some differences in the new indices,” said Joel Dickson, senior investment strategist at Vanguard’s Investment Strategy Group. “[South] Korea is by far the biggest change,” he said.

The FTSE Emerging Index excludes the country, as it is classed as a developed market, while the MSCI Emerging Markets Index categorises it as an emerging one.

“We think it is a good thing not having such a large weight in Korea and giving more exposure to other emerging markets such as India or Russia,” he said.

Definitions of mid-cap and small-cap stocks are also different in the new indices but Mr Dickson said Vanguard was “working hard to make investors aware of how their portfolios will change”.

He said investors would benefit from “tracking exposure to the new indices at a lower cost than previous ones”, particularly over the long-term.

But it may have cost Vanguard some business in the short term.

The fund manager reported outflows of about $900m for the fourth quarter of 2012 from its emerging markets ETF, known as the VWO, following the decision to change index providers. However, overall the 22 index funds changing benchmarks saw about $9bn of inflows in the last two months of 2012, while the emerging markets ETF has made a positive start to 2013, taking in $1.4bn of new money (to 29 January), according to ETFGI, which tracks fund flows.

“Time will tell whether or not the shift has been a mistake. The costs of such a switch is huge – such change is a real cost to investors,” said Alex Matturri, chief executive of S&P Dow Jones.

Analysts have also questioned if Vanguard has made a strategic mistake as the index switch appears to have benefited the directly competing emerging markets ETF offered by iShares, known as EEM.

VWO had been winning market share from its iShares rival over the past three years but that reversed after the announcement of the index switch with EEM grabbing inflows of $8.9bn in the fourth quarter.

Luke Montgomery, an analyst with Bernstein Research, said: “One wonders whether the cost savings of the index switch were worth the risk of forgoing further asset accumulation for Vanguard.”

Mr Montgomery noted that Vanguard could make such choices without having to worry about any impact on profits as it is a mutually-owned company.

In contrast, BlackRock has been careful to emphasise that the ETF fee reductions it announced last year would only have a minimal impact on its earnings.

However, Bill McNabb, Vanguard’s chief executive has promised that it will continue to look for cost savings that can be passed on to investors, setting the stage for more battles in the price war between ETF

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