Vanguard CIO on benchmark change: Mission complete
June 27, 2013
With Vanguard Emerging Markets Stock Index Fund's transition to the FTSE Emerging Index in June, the shift of 22 Vanguard funds and their ETF Shares to new target benchmarks was brought to a successful close. We spoke with Tim Buckley, Vanguard's chief investment officer, to get his take on Vanguard's move to benchmark indexes developed by FTSE and the University of Chicago's Center for Research in Security Prices (CRSP).
Take us back to the "why." Can you give some insights on the decision to change benchmarks?
We are on a relentless pursuit to provide the highest-value investment options. The cost associated with licensing benchmarks was on the rise, and it was becoming a disproportionately large part of an index fund's expense ratio.
As one of the largest index fund providers in the world, we were in the position to secure agreements for high-quality indexes that we expect to result in considerable long-term savings for our index investors.
Why did Vanguard select benchmarks from FTSE and CRSP?
Cost, cost certainty, construction, and coverage. As I've already noted, our agreements with FTSE and CRSP are very favorable from a cost perspective, and they will help us to further reduce the expenses of our index funds and ETFs. Equally important, the agreements are long term, which gives us cost certainty over a very long period of time.
"The transitions went very smoothly and we expect investors will benefit from the cost savings and cost certainty associated with these transitions for many years to come. Investor reaction has been overwhelmingly positive. Our clients understood that we were taking a stand on their behalf, and they appreciated our efforts to lower costs."
From a construction standpoint, the indexes from FTSE and CRSP meet Vanguard's "best practice" standards for market benchmarks. These indexes incorporate full-float adjustment to reflect only those shares that are available and freely traded on the open market, providing a more accurate reflection of market movements. They buffer stock movement between market-capitalization segments, helping to reduce index turnover. They also incorporate multiple criteria to identify growth versus value. And they engage in gradual, orderly rebalancing to reflect market changes.
From a coverage standpoint, FTSE and CRSP offer comprehensive market coverage. FTSE indexes comprise more than 7,400 securities in 47 different countries and capture 98% of the world's investable market capitalization. CRSP indexes include nearly 4,000 constituents across mega-, large-, mid-, small-, and micro-capitalizations, representing 100% of the U.S. investable equity market.
Beyond the benchmarks, tell us a bit more about the two companies.
We have had a long relationship with FTSE, and we understand and value their approach. Prior to the transition, Vanguard used FTSE's benchmarks for more than 20 index products around the world that together represented $26 billion in assets.
FTSE is a leading provider of index data for institutional investors worldwide, with more than $3 trillion of assets benchmarked to their indexes. FTSE combines global expertise with local market knowledge to create both global and local benchmarks across a range of asset classes. With regard to CRSP, we're impressed by the quality and depth of its staff, as well as their experience. The research organization pioneered the development of U.S. stock market data in 1960 that are widely used in academic and investment research.
How successful was Vanguard at managing the transitions?
The transitions, which involved more than $650 billion in 22 funds, were a great success.
Our portfolio managers were able to minimize transaction costs through the use of efficient portfolio trading proprietary strategies developed over many years. Throughout the transitions, our tracking precision met our high standards. While index tracking error increased modestly, as expected, for a few portfolios around their transition dates, all of the funds are being managed against their new benchmarks with tracking errors near or below their pre-transition levels. In addition, we do not expect the transitions to result in capital gains distributions to shareholders.
The bottom line: The transitions went very smoothly and we expect investors will benefit from the cost savings and cost certainty associated with these transitions for many years to come.
How have investors responded?
Investor reaction has been overwhelmingly positive. Our clients understood that we were taking a stand on their behalf, and they appreciated our efforts to lower costs. Through May 31, more than $48 billion has flowed into the 22 index funds involved in the move since our October 2012 announcement, which represents 50% of Vanguard's total cash flow over the period.
Equally gratifying is to see how the passive strategy continues to gain converts. Year-to-date through May, clients have invested more than $83 billion in Vanguard's index funds and ETFs, including an industry-leading $27.2 billion in flows to Vanguard’s U.S.-based ETFs.
To what do you attribute their response?
There are a few reasons. One is the strength of Vanguard's brand, which investors have come to trust—trust in our indexing leadership and trust in our track record for doing the right thing for our shareholders.
Another is our commitment to providing the highest-quality investment options. Vanguard has long been a low-cost leader, part of which can be attributed to our unique corporate ownership structure. Vanguard is owned by our funds—and thus, in turn, collectively owned by the fund shareholders. We provide services at cost, passing savings to the fund investors. It's a structure that enables us to pass along economies of scale—and reduce expenses—as fund assets grow. But it is also our culture of cost consciousness, of striving for efficiencies, and spending wisely. Our structure and our culture are a powerful combination.
A third reason: The quality of the FTSE and CRSP benchmarks. As investors evaluated them, they quickly determined that these are quality indexes from quality providers, which offer substantially similar market exposure compared with the previous benchmarks.
We're happy that the transition is complete. More important, we'd like to take this opportunity to thank our clients. A change of this size and scope required some of our institutional and advisor clients to revise investment policy statements or gain approval for the change from an investment committee. So, we are grateful that our clients remained loyal to Vanguard during the transition period. From our perspective, it was six months of considerable work and change that will result in many years of benefit.
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