Vanguard announced in June 2015 it was planning changes to its benchmarks for foreign index stock market funds. Those changes start now and it is good news for investors.
Vanguard announced on November 1, 2015 that its Emerging Markets Fund (VEMAX/VEIEX/VWO) will now start to transition to a new tracking index over a 12-month period. The change will be to an index that covers a larger universe of equities. Currently, the fund limits exposure to China and does not include small cap equities. The benchmark will eventually change to the FTSE Emerging Markets All Cap China A Inclusion Index by using a “transition index.” The bottom line is that the new benchmark will provide investors a more broad-based fund, and the expense ratio is expected to remain unchanged.
Even better, Vanguard’s Developed Markets Index Fund (VTMGX/VDVIX/VEA) will add both small cap issues and add coverage of Canada (large and small). That is right, the index currently does not include any small cap and has no coverage of Canada, even though it clearly is a developed market. You had to buy the Total International Fund or a separate Canada fund to get Canada. The new benchmark will be the FTSE Developed All Cap ex US Index.
For those whose international exposure is investment in the Vanguard Total International Stock Index Fund (VTIAX/VGTSX/VXUS), there is no change, because that fund already tracks the FTSE Global All Cap ex US index. This means you already have coverage to all markets, including Canada (6.4% of the index) and China (4.6%). This fund has 6,018 holdings, including small cap, and more than the underlying index (which has 5,718).
For those who slice and dice, you may need to make some adjustments. If you currently have a Developed Markets fund, a Small Cap fund, an Emerging markets fund, and a Canada fund, you can downsize to just the Developed Markets fund and the Emerging Markets fund, since both would include small cap, and the developed fund would now include Canada. If you slice between Europe and Asia, it is also good news since those funds too will be expanded to include small caps.
These changes are not going to happen overnight.
According to Vanguard,
The transition index will be used for approximately one year to reduce the costs associated with trading large amounts of securities in a short period. The fund will sell large-cap and mid-cap stocks on a monthly basis while proportionally adding exposure in China A-shares and small-cap ex China A-shares based on each security’s weight in the index (see chart below). At the end of the transition period, the fund will begin tracking the FTSE Emerging Markets All Cap China A Inclusion Index.
The Emerging Markets Stock Index Fund will be the first broad-based market-cap-weighted index fund to include both all-cap exposure and China A-shares.2 The changes will move the fund closer to market-cap weightings and provide investors with more complete and diversified exposure to a key emerging economy and the second-largest stock market in the world by market cap.3
As of September 30, 2015, the FTSE Emerging Markets All Cap China A Inclusion Index included 1,856 small-cap companies (11.3% of the index) and 1,454 China A-shares (5.79% of the index).
The fund’s expense ratios aren’t expected to be affected by the transition to the new benchmark, which was among changes to four U.S.-domiciled international equity index funds and ETFs announced earlier this year. Two of those funds, Vanguard European Stock Index Fund, and Vanguard Pacific Stock Index Fund, began tracking all-cap indexes October 1. The other fund, Vanguard Developed Markets Index Fund, is expected to begin tracking a transition index that includes small-cap equity exposure and Canadian stocks by the end of 2015.
I am looking forward to these changes, particularly because they are being done in the interest of investors to improve diversification of the broad index products. For those who currently hold these funds, but do not want the exposure to small caps, you will need to consider changing to large-cap-specific index funds, such as the Schwab International Index Fund® (SWISX) or the iShares EAFE (EFA) ETF, both which track the MSCI EAFE (large cap only) Index.