We understand change can be challenging, but it can also mean opportunities.
Take our recent announcement with respect to the adoption of new FTSE benchmark indexes for our international equity mutual funds and exchange traded funds (ETFs). [Vanguard Index Trade ‘All About Costs’]
We believe these indexes offer broad exposure to international markets, and we expect long-term licensing arrangements with FTSE will enable us to deliver considerable expense saving over time.
At the same time, we understand that for some investors this change may be problematic. FTSE classifies South Korea as a developed market, while MSCI classifies it as an emerging market. This means for your developed and emerging markets exposure, you may want to own ETFs that seek to track indexes from either FTSE or MSCI, but not both. If you mix and match, you may own too much South Korea, or none at all.
It’s a dilemma that’s led some investors to reevaluate their holding of Vanguard Emerging Markets Stock Index Fund and ETF (NYSEArca: VWO).
A cost savings opportunity
Herein arises the opportunity. Investors may achieve cost savings by keeping VWO for emerging markets exposure and switching their developed international markets exposure to Vanguard MSCI EAFE (NYSEArca: VEA).
Let’s do the math.
For market-cap-weighted models, broad international stock exposure is gained by allocating about 75% to developed markets and about 25% to emerging markets.
The expense differential in basis points (bps) is clear when we compare our emerging and developed markets ETFs with those iShares ETFs to which they are generally compared. We compare ETFs—not traditional mutual fund shares— because iShares does not have mutual fund shares.
Our emerging markets ETF—the third-largest ETF in the United States, with total assets of $57.4 billion—has a 47 bps advantage over the $37.2 billion iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM). And our $9.3 billion developed markets ETF has a 22 bps advantage over the $36.4 billion iShares MSCI EAFE Index Fund (NYSEArca: EFA). All assets are as of September 30, 2012.
By comparing these ETFs, we are comparing international ETFs that are close in size—they are all among the largest available—and have similar bid/ask spreads. For example, VWO and VEA had average spreads in the third quarter of this year of 0.02% and 0.03%, respectively. EEM and EFA each had an average spread of 0.02%.
There are newer, smaller discount products on the market. But understand that their relatively low trading volume contributes to wider spreads (and potential market impact costs) that may erase any modest expense ratio advantage.
So let’s look at what the differentials mean to a financial advisor and retail investor, in terms of dollars paid over a one-year period. The following examples do not include the brokerage commissions that you may pay to buy and sell ETFs.
Suppose a $10 million international allocation for an advisor, with $7.5 million going to developed markets and $2.5 million to emerging markets.