Vanguard Launches Assault On Barclays' ETF Dominance With New MSCI EAFE Fund

Vanguard has launched a full and frontal assault of Barclays Global Investors’ (BGI’s) dominance in the ETF marketplace. And investors stand to benefit.

Vanguard has filed papers with the SEC for the right to launch a new ETF tied to the MSCI EAFE Index. That index, of course, is the same one tracked by the $45 billion iShares MSCI EAFE ETF (NYSE: EFA), BGI’s flagship ETF and the second largest ETF in the world.

The development is good news for investors, as Vanguard plans to price its ETF very aggressively, charging just 0.15% in expenses compared to 0.35% for EFA.

The Vanguard ETF will trade on the American Stock Exchange (AMEX) under the ticker symbol VEA. It will be called the Vanguard Europe Pacific ETF.

The prospectus is available here.

A Challenge To BGI

The move is part of a broader effort by Vanguard to challenge BGI on the fee front … an effort that appears to be paying off for the indexing giant.

Late last year, Vanguard changed the benchmark on its Emerging Markets ETF (AMEX: VWO) so that it tracked the exact same benchmark as the popular iShares Emerging Markets ETF (AMEX: EEM). With the two funds offering substantially identical exposure, investors began to focus on the fees, where Vanguard has a clear edge: VWO charges just 0.30% in expenses, compared to 0.75% for EEM. Since then, the momentum in fund flows has favored Vanguard: in Q1 2007, for instance, VWO pulled in $637 million in net inflows, while EEM posted small net outflows.

The same thing could happen with the new Vanguard EAFE ETF, which will offer substantially similar exposure to the BGI fund.

The Vanguard ETF will be a share class of the Vanguard Tax-Managed International Fund [VTMGX], a passively managed fund with a nearly eight year track record. That means that VEA and VTMGX will hold the same securities and receive the same returns. before fees. (All Vanguard ETFs are structured as share classes of existing Vanguard funds, as opposed to stand-alone funds, as is the case for other ETFs.)

As a tax-managed fund, VTMGX does make certain trading decisions that other index funds wouldn’t make: it sells securities with unrealized capital losses in an effort to lock down tax benefits. But the impact of these trades has been negligible on performance: to date, VTMGX has done a good job tracking its benchmark. In fact, over the past five years, VTMGX has slightly outperformed its benchmark index, delivering 16.66% compound returns vs. 16.64% for the MSCI EAFE.  

The table below compares the return series for the two funds and the benchmark index through 4/30/07. All returns are annualized.

Note that the short-term returns for the Vanguard fund differ from those available on Vanguard’s Web site. The Vanguard site features “fee-adjusted” returns, which reflect a 1% redemption fee charged on all accounts held for less than five years. That reduces the reported 1- and 3-year returns.  That fee will not apply to the new ETF, so it is more appropriate to compare results on a non-fee-adjusted basis.

Over 1-year, EFA tracks closer to the index than the Vanguard fund. But over 3- and 5-years, Vanguard has the edge. Given the similarities, the 0.20% expense ratio differential may be enough to convince investors to consider the new Vanguard fund.

Comments

[Frank Li]

Question: Will Vanguard will get this off the ground, given that the index is indentical to another ETF's?

Look what happened with GLD and IAU -- State Street got GLD out before Barclays launched IAU, and GLD now owns the market.