What Vanguard’s Index Swap Means for ETF Investors

October 20th at 7:14am by Tom Lydon

Vanguard took the ETF fee war to a whole new level after announcing the switch to FTSE and CRSP indices from MSCI benchmarks. Now, investors will have to brace for potential changes and the effects on their portfolio allocations.

In a related move, BlackRock (NYSE: BLK) recently lowered expense ratios at six of its iShares funds. It also launched the new iShares Core Series targeting long-term investors. [The Phony ETF Fee War?]

Vanguard will be switching out the benchmarks on 22 of its index funds. The largest funds to swap out their index include the Vanguard Emerging Markets Index (NYSEArca: VWO), which will track the FTSE Emerging Index, and the Vanguard Total Stock Market (NYSEArca: VTI), which will follow the CRSP Total market Index, Dan Culloton, associate director of fund analysis for Morningstar, said. [Vanguard Benchmark Trade Shakes Up Index Industry]

While retail investors may be unfamiliar with the CRSP brand, the index provider, which is based out of the University of Chicago Booth School of Business, has been around since 1960 and is well known among academic financial circles.

CRSP’s methodology also differs slightly from MSCI’s approach.

“They use a different method of moving stocks across market cap and style boundaries in their indexes–where it’s more gradual and allows for stocks to be held in more than one index at a time, which could reduce turnover over time,” Culloton said. “They add some, I guess you would call them, earnings quality metrics, such as looking at current assets and return on assets in their growth factors, which could also have a difference in exposures over time. ”

“CRSP breaks up its market-cap boundaries by a percent of market cap,” Culloton added. “So its large-cap index, instead of being the 750 largest stocks, would be the top 85% of the market.”

Culloton expects the changes to gradually faze in over the next couple of months and maybe well into 2013 before it is complete.

“They do this just to reduce the market impact cost and the transaction cost of the overall change,” Culloton said.

Once the change is implemented, investors will have to consider the indices’ exposure and allocations. Specifically, investors will need to watch out for changes in holdings, sectors, regions and market capitalization. For instance, FTSE does not categorize South Korea as an emerging market, whereas MSCI will included the country in its emerging market index.

Moreover, investors will have to keep an eye on turnover and tracking errors. If the new indices prove to be less efficient than expected, the ETFs will not perform as well as alternative options.

For more information on the ETF industry, visit our current affairs category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, 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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