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%

Comparing 10-year Annual Returns of Emerging Market Indexes

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.

This article has 9 comments

  1. Great post CC.

    I own VTI, VEA and VWO. Lately they`ve been sending me their prospectus in the mail and I`ve been wondering why.

    Maybe I should read them.

    • Thanks for your comment Andrew. The stuff Vanguard sent you in the mail is probably their quarterly report. I find it useful to at least glance through it. It has useful data such as p/e ratio, p/b ratio, dividend yields etc. I guess Vanguard would send out documentation of the benchmark change soon as well. The tldr; version of the change is that as far as I can tell, investors can safely ignore it!

  2. Great news. Will include this week in my roundup CC.

    Great to read ETFs I own (VTI and VWO) could be lowering MER; the turnover from this type of transition should be a minor concern to most individual investors I would suspect.

    Nice to see VWO returning quarterly distributions as well.

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  5. One of the reasons I wanted to invest in the MCSI index tracking funds was for its strong weighting in South Korea. Not necessarily low correlation to NA, EAFE, but strong growth prospects in that country. Oh well, time will tell whether it is provides sufficient diversification from developed markets.

    • It appears that FTSE reclassified South Korea as “developed” just 3 years back. The country is on the upgrade watchlist of MSCI as well. Korea makes up 5.5% of the Developed market index, so assuming an investor has proportionally more allocated to developed markets compared to emerging markets, Korea’s allocation will remain roughly the same.

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