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Indexing Fans Have a Lot to Thank Vanguard for This Year

The firm has continued to improve its passive lineup. 

William Samuel Rocco, 11/21/2011

Vanguard has been the leader in the field of index funds for decades. It launched Vanguard 500 Index VFINX, which has $102 billion in assets and is the third-largest stock fund in the United States, back in 1976. It opened Vanguard Total Stock Market Index VTSMX, which has $162 billion in assets and is the largest equity offering in the U.S., nearly 20 years ago. And it has dozens of other index funds that span the asset-class, geographic, and style spectrums as well as lots of funds of funds that hold mixes of its passive offerings.

Meanwhile, Vanguard has done an excellent job of driving down costs, choosing appropriate benchmarks, and replicating the performance of those benchmarks across its index lineup. (The firm has considerable success using various techniques--such as sampling, employing futures contracts, and lending securities--to track benchmarks efficiently and effectively.) The firm's passive roster is packed with topnotch offerings. We have evaluated a good number of its index offerings and passive funds of funds thus far using the new Morningstar Analyst Rating, in fact, and these funds have received impressive ratings overall.

Vanguard has made four important moves in 2011 that should make its passive lineup even more attractive to indexing fans. Here are the details on each of the moves.

Making Saving for Retirement Even Easier
Vanguard lowered the minimum initial investment on the 12 funds of funds in its target-retirement series to $1,000 from $3,000 this spring. These offerings are designed to be one-stop retirement solutions, range from funds for individuals who have already stopped working to offerings for those who will retire decades in the future, and automatically make their asset mixes more conservative over time. The same is true of funds in other target-date series, of course, but the Vanguard target-retirement offerings rank among the best such options around. These offerings, which invest in a handful of the firm's index funds in varying proportions, have received Gold Morningstar Analyst Ratings thanks to their low costs, the superior quality of the underlying funds, and Vanguard's overall commitment to serving investors well. Thus, the lower minimum initial investment on these offerings should be a welcome development for indexing fans, particularly given how important it is to start retirement savings early.

Expanding The Admiral Fleet
Vanguard opened Admiral share classes for four domestic-equity and two international-stock index funds in September, including Vanguard Small Cap Value Index Admiral VSIAX and Vanguard Developed Markets Index Admiral VDMAX, with expense ratios ranging from 0.10% to 0.21% and minimum initial investments of $10,000. These moves follow the firm's late-2010 launch of a similarly cheap and accessible Admiral share class for Vanguard Total International Stock Index VTIAX and its October 2010 decision to lower the investment minimums on the pre-existing Admiral share classes of its broad stock and bond index funds. As a result, Vanguard now offers Admiral share classes for 28 U.S.- and foreign-equity index funds with ultralow expense ratios and minimum initial investments of $10,000.

Aficionados of passive strategies should be pleased. Every basis point counts with index funds. The Admiral share classes are significantly cheaper than their Investor share-class counterparts--which are quite attractively priced themselves--and rank among the very cheapest mutual funds around. (There are a few exchange-traded funds that have similarly low expense ratios and track the same or similar indexes as some of the Admiral-share-class funds.) Cutting the minimum initial investment to $10,000 makes these funds accessible to a much wider audience. And the overall quality of these funds is exceptionally high. Indeed, Vanguard Developed Markets Index Admiral, Vanguard Total International Stock Index Admiral, Vanguard 500 Index Admiral VFIAX, and 10 others are Gold-rated offerings.

Restructuring Four Funds of Funds
Vanguard recently began to transform the four funds of funds in its LifeStrategy Series into purely passive offerings. Specifically, it is gradually selling their active components, namely Vanguard Asset Allocation VAAPX (which is held by all four LifeStrategy funds) and Vanguard Short-Term Investment-Grade VFSTX (which is owned by the two more-reserved offerings in the series). It is moving the assets into their three passive components-- Vanguard Total Stock Market Index VTSMX, Vanguard Total International Stock Index VGTSX, and Vanguard Total Bond Market II Index VTBIX--in accordance with each LifeStrategy fund's risk/reward profile.

These changes eliminate active manager execution risk, which wasn't a problem at Vanguard Short-Term Investment-Grade but has been at Vanguard Asset Allocation--so much so that Vanguard plans to merge the fund away. Moreover, Vanguard Total Stock Market Index, Vanguard Total International Stock Index, and Vanguard Total Bond Market II Index are among the cheapest, most broadly diversified, and well-managed index funds in their respective categories. Thus, the modified versions of these funds should have real appeal to investors who are seeking wide-ranging passive hybrid vehicles.

William Samuel Rocco is a senior fund analyst with Morningstar. He would like to hear from you, but he cannot provide individual-portfolio or financial-planning advice.
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