Vanguard To Drop MSCI Index On VWO

October 02, 2012

Changing Indexes

Several of Vanguard's largest and most widely held index funds will change their benchmarks, including:

  • Vanguard Total Stock Market Index Fund and ETF (NYSEArca: VTI), which will move from the MSCI U.S Broad Market Index to the CRSP US Total Market Index
  • Vanguard Emerging Markets Stock Index Fund and ETF (VWO), which will move from the MSCI Emerging Markets Index to the FTSE Emerging Index. To ease the transition of portfolio holdings, the change will occur in two phases with the fund moving temporarily to the FTSE Emerging Transition Index before shifting to the FTSE Emerging Index.

The benchmarks for Vanguard Target Retirement Funds, LifeStrategy Funds, Managed Payout Funds, and other funds-of-funds will also change.

For these funds-of-funds, the MSCI All Country World ex USA Investable Market Index and MSCI US Broad Market Index components of the composite indexes will be replaced by the FTSE Global All Cap ex US Index and the CRSP US Total Market Index.

Asset allocations for the funds-of-funds will not change.

Again, Sauter said the transition hasn’t yet begun, and won’t be done until sometime next year.

But he did say that VWO’s temporary index will have an allocation to South Korea that Vanguard’s portfolio management team will trim the Korea position from the portfolio by 4 percent each week for a 25-week period.

VWO: Different But The Same

The Korea difference is substantial and relates to how FTSE views the emerging markets investment universe.

“We classify South Korea as a developed country,” said Jill Mathers, a FTSE spokeswoman in New York.

“Obviously not having companies like Hyundai, Kia and Samsung is a big difference,” she added, referring to three South Korean companies that are at the center of the country’s modern, high-tech economy.

“We do think that South Korea is a developed country,” Sauter told IndexUniverse.

While Korea’s absence from the FTSE index is big, it’s not clear that returns would be all that different given correlations of returns between different rapidly growing countries, as IndexUniverse ETF Analyst Paul Baiocchi pointed out in a blog earlier this year. If Korea made a positive difference in the past decade, it's not at all clear it will keep making a difference.

In any case, apart from the Korea difference, VWO’s new benchmark isn’t all that different from the MSCI index it has been using.

The FTSE Emerging Index is a free-float-weighted benchmark that comprises some 793 securities in 23 countries, according to information on the company’s website.

Like its MSCI counterpart, both benchmarks hold financials as their top sector allocation at about a quarter of the portfolio.

While their country exposures are also similar, FTSE’s is broader, as it includes allocations to Pakistan and the United Arab Emirates—at 0.12 percent and 0.34 percent weightings—two countries not found in the MSCI Emerging Markets Index.

Still, both indexes hold China as their single largest country allocation at about 17 percent of the total basket. Their second largest country allocation is Brazil, but in FTSE it represents 16 percent of the total compared with 13 percent in MSCI’s Emerging Markets Index.

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