Vanguard Index Switch Sets Emerging Market ETF Showdown

October 2nd at 2:10pm by John Spence

There are several moving parts to Vanguard’s announcement Tuesday that it’s changing the tracking benchmarks for several of its index funds, but one of the most interesting subplots involves its emerging markets ETF.

Vanguard MSCI Emerging Markets (NYSEArca: VWO) will transition to the FTSE Emerging Index at some point next year.

In terms of gathering assets, VWO has been crushing iShares MSCI Emerging Markets (NYSEArca: EEM) in a head-to-head match-up in recent years. They track the same MSCI index but the Vanguard ETF plans to shift to a FTSE benchmark. [Vanguard Changing Indices]

The Vanguard emerging market fund, VWO, is the best-selling ETF in 2012 with inflows of $11.5 billion, according to Index Universe data. EEM has gathered $1.6 billion.

Investors have been favoring the lower-cost Vanguard ETF for emerging markets. VWO has an expense ratio of 0.2% compared with 0.67% for the iShares ETF.

Yet Vanguard moving to a different index means that investors won’t compare the ETFs on costs alone anymore.

Also, many pension funds and institutional investors use MSCI indices for their international benchmarks. That may cause some large investors to drop the reconstituted Vanguard ETFs for iShares funds that follow MSCI’s international benchmarks.

South Korea

There is a major difference between the emerging market indices managed by MSCI and FTSE in terms of country allocations.

“FTSE counts South Korea as a developed market and hence, does not include the country in its emerging markets index. MSCI still considers South Korea an emerging market,” says Daniel Wiener, editor of The Independent Adviser for Vanguard Investors.

“The country’s stocks represent about 15.5% of the index weight with Samsung Electronics Co. Ltd. the largest single company in the MSCI index at an almost 4% weighting,” he added.

Brendan Conway at Barron’s estimates the Vanguard emerging markets ETF may have to unload as much as $9 billion in exposure to South Korea at some point.

Vanguard said the transition to the new benchmarks is not expected to result in capital gains distributions to the funds’ shareholders.

In any case, investors will be closely watching the performance of the competing emerging market ETFs to see if Vanguard adopting a FTSE index results in a performance edge or disadvantage.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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