Vanguard’s US-listed ETFs such as Vanguard Total Stock Market Index ETF (VTI), Vanguard MSCI EAFE ETF (VEA) and Vanguard MSCI Emerging Markets ETF (VWO) are popular among Canadian index investors because they offer a cheap way to diversify into global stock markets. Investors in these ETFs should take note of a recent announcement by Vanguard that these ETFs will shortly switch from tracking indexes provided by MSCI to indexes provided by Center for Research in Security Prices (CRSP) for the US market and FTSE for international markets.
Vanguard says that the change will help it save millions in benchmark licensing fees it currently pays to MSCI Inc (in response to the news MSCI’s stock dropped by more than 25%). In turn, due to Vanguard’s ownership structure, investors can expect the savings to pass through to them over time in the form of lower expense ratios. VTI, VEA and VWO currently charge a MER of 0.06%, 0.12% and 0.20% respectively and investors can expect these MERs to fall even lower!
A key concern when an index mutual fund or ETF changes its benchmark is turnover. Turnover negatively impacts investors through a one-time increase in trading costs and could trigger capital gains distributions. Vanguard does expect some extra turnover from the transition but says that it doesn’t expect any capital gains distributions.
Impact of Benchmark Change on Vanguard Emerging Market ETF (VWO)
Unfortunately, it does look like the change in indexes needs to be analyzed carefully. The new indexes that VTI, VEA and VWO will track look quite different from the MSCI indexes that they currently track. Let’s consider the case of VWO, which currently tracks the MSCI Emerging Markets Index and will start tracking the FTSE Emerging Index. Here’s a comparison of the annual returns of the two indexes for the past 10 years:
| Year | FTSE EM Index | MSCI EM Index | Delta |
|---|---|---|---|
| 2002 | -6.10% | -6.17% | 0.07% |
| 2003 | 54.00% | 55.82% | -1.82% |
| 2004 | 27.90% | 25.55% | 2.35% |
| 2005 | 35.10% | 34.00% | 1.10% |
| 2006 | 33.10% | 32.17% | 0.93% |
| 2007 | 39.70% | 39.39% | 0.31% |
| 2008 | -52.90% | -53.33% | 0.43% |
| 2009 | 82.60% | 78.51% | 4.09% |
| 2010 | 19.80% | 18.88% | 0.92% |
| 2011 | -19.00% | -18.42% | -0.58% |
| Total | 387.75% | 366.14% | 21.61% |
One of the reasons for the substantial return differential in some years could probably be attributed to the classification of South Korea, which has a 15.4% weighting in the MSCI Emerging Markets Index as a developed country in the FTSE indexes. Therefore, the country weightings of other emerging markets in the MSCI Emerging Markets Index are somewhat different from the FTSE Emerging Index.
| Country | FTSE Emerging Index | MSCI EM Index |
|---|---|---|
| China | 16.72% | 17.30% |
| South Korea | 15.40% | |
| Brazil | 16.09% | 13.15% |
| Taiwan | 13.23% | 10.95% |
| South Africa | 10.56% | 8.01% |
Apart from the country weightings, the two emerging market indexes look fairly similar. This might explain the roughly similar risk-reward profile in the annual returns.
| FTSE Emerging Index | MSCI EM Index | |
|---|---|---|
| No. of stocks | 793 | 820 |
| Total Market Cap | $3.3 Trillion | $3.4 Trillion |
| Average Market Cap | $4.2 Billion | $4.1 Billion |
| Median Market Cap | $1.8 Billion | $2.0 Billion |
In future posts, we’ll take a look at the impact of the benchmark change on the Developed Market ETF and the US Total Stock Market ETF.
