Vanguard to S&P: You … Complete … Me

May 04, 2005

After years of moving assets away from S&P, Vanguard has embraced a new S&P index for its Extended Market fund.

Spring is in the air, and two indexing giants are falling back in love

Vanguard announced plans today to switch the benchmark for its $9 billion Extended Market Index Fund from the Dow Jones Wilshire 4500 to a new S&P product called the "Completion Index."  That news stunned the indexing industry, as Vanguard has spent most of the past two years aggressively moving funds away from S&P indexes.

The two indexing giants had a famous falling out in 2001 over licensing fees for Vanguard's exchange-traded funds, the VIPERS.  Since then, Vanguard has changed the benchmark for seven funds with assets of over $20 billion from S&P indexes to competing products from MSCI.  The only fund to escape Vanguard's wrath was the granddaddy of them all, the Vanguard 500 Index Fund, the world's largest index fund with $84 billion in assets.  Critics wondered when that last string to S&P would be severed.

It looks like they can keep on wondering.

By embracing S&P for the Extended Market fund, Vanguard has solidified its relationship with S&P in a major way, and has created a fund that directly complements the Vanguard 500.  The new S&P Completion Index is intended to provide exposure to substantially all investable American companies that are not included in the 500 index.

"We are constantly looking for the best benchmarks for our funds," said Gus Sauter, who heads up operations at Vanguard.  "We wanted to move away from the Wilshire index because it is not float-adjusted. We looked at what was available on the marketplace and found that we liked the construction of S&P's index the best."

While Wilshire does offer a float-adjusted version of its 4500 index, Sauter said that S&P had the edge in other areas.  Specifically, Vanguard agreed with S&P's subjective approach to determining how a company qualifies as "American."  While some indexers - including Wilshire - rely on the location of a company's official headquarters as the sole criterion, S&P evaluates more broadly where that company conducts the bulk of its business.

As one example, Southern Peruvian Copper (NYSE: PCU) is headquartered in New York, but is - as the name suggests - a Peruvian mining company operating out of Peru.  PCU is included as American in the Wilshire indexes, while it is excluded from the S&P.

"We take [this deal] as a sign that people appreciate the idea that careful review - as opposed to the brutal application of a set of rules - is a very good way to run an index," said David Blitzer, Ph.D., chairman of the indexing committee at S&P.   "Vanguard is a good organization, and we're pleased to be working with them."

The Standard and Poor's What???

If you haven't heard of the Completion Index, you're not alone.  In fact, until today, no one had heard of the index … because it didn't exist. S&P has been working on the index with Vanguard in mind, and today's announcement is the first public mention of the product. S&P has yet to publish data on the index's construction methodology or constituents; the company said data would be available "later this year."

And while neither party is eager to release details, they were willing to offer a broad outline of the product: 

  • The index - complementing the S&P 500 - will attempt to provide total coverage of the U.S. marketplace.
  • As such, the index will cover a much broader range of market capitalization than the S&P's current broad market index, the S&P 1500.  Companies must have a market capitalization of $300 million to enter the S&P 1500; the barrier will be much lower for the Completion Index.
  • The index will be float adjusted.
  • The index will not include limited partnerships.
  • The index will follow the same general rules as the S&P 500.
  • The index will be optimized by Vanguard - that is, Vanguard will not hold all the names in the index, but a liquid subset delivering returns comparable to the index as a whole.  Vanguard optimized the Wilshire 4500 in the past.


In related news, Motley Fool and a number of other media outlets have written articles noting that Sauter is signing off as portfolio manager for a number of Vanguard funds, including the Vanguard 500 Index Fund and Total Stock Market Index Fund.  The articles suggest that Sauter will be taking on broader responsibilities at Vanguard.

According to Sauter, however, the change is a technicality, and won't alter the operations of the funds.  Sauter said that a new Securities & Exchange (SEC) regulation requires companies to name the individual in charge of "day-to-day operations" as the manager of each fund. Sauter oversees the entire indexing group, and says that he hasn't been doing the day-to-day work in quite some time.  To keep up with the new SEC regulation, Vanguard is changing the name on the letterhead.

"We really manage our index funds in a team approach, and we will continue to do so," said Sauter.  "Nothing substantial has changed."


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