Vanguard to Switch Benchmarks for 22 Index Funds

In a decision sure to send tremors through the passive investing world, Vanguard on Tuesday said it will change the benchmarks of 22 domestic- and international-stock mutual funds and exchange-traded funds in an effort to reduce overall ownership costs for investors.

It's dropping MSCI indexes for bogies constructed by FTSE for foreign-stock funds and the University of Chicago's Center for Research in Security Prices, or CRSP, for most of its domestic-equity funds. The change affects funds with a total of $537 billion in assets or more than a fourth of Vanguard's total assets.

Vanguard says FTSE and CRSP are giving it and its investors a better deal than MSCI gives. "We negotiated licensing agreements for these benchmarks that we expect will enable us to deliver significant value to our index fund and ETF shareholders and lower expense ratios over time," said Vanguard chief investment officer Gus Sauter in a statement.

Losing Vanguard, which is the largest mutual fund company with nearly $2 trillion in assets under management, is a blow to  MSCI (MSCI), whose shares plunged by nearly 30% following the announcement.

Licensing fees comprise a large and growing part of index fund expenses. Nearly a third of the  SPDR S&P 500's (SPY) 0.09% expense ratio, for example, goes to Standard & Poor's. Index providers are coming under increasing pressure, though, as index mutual fund and ETF companies compete fiercely on price and seek to reduce fees any way they can.

Vanguard's move comes less than 10 years after the family first adopted and began phasing in MSCI indexes for most of its core U.S. equity index funds and ETFs. At the time, the family said MSCI's objective rules, float-adjustment, and overlapping market-capitalization buffer zones for its indexes were the cutting edge in benchmark-construction methodology. At the time, current Vanguard CIO Sauter contended the indexes would help lower turnover and better capture the returns of its funds' targeted market segments.

On Tuesday Sauter said, "The indexes from FTSE and CRSP are well constructed, offer comprehensive coverage of their respective markets, and meet Vanguard's 'best practice' standards for market benchmarks."

Vanguard will be CRSP's first indexing client, but the university research center has been collecting and studying stock market data since 1960, and its market-cap-weighted indexes, which Vanguard helped develop, have been around since 2009. The CRSP indexes could improve on the way MSCI moves stocks among adjacent indexes. They use a method called packeting to shift companies' shares as they drift over the index's size and style boundaries indexes. The indexes also allow holdings to be shared by two indexes of the same family and randomly make constituent changes. That's supposed to reduce trading and impact cost and make it harder for active investors to front-run changes to the index.

Vanguard will switch a total of 16 stock and balanced funds with $367 billion in assets to the CRSP indexes, including the family's $197 billion flagship fund  Vanguard Total Stock Market Index (VTSMX) and its  ETF share class (VTI), which will move from the MSCI U.S. Broad Market Index to the CRSP U.S. Total Market Index.

The move also expands Vanguard's relationship with FTSE, which the family began using in 2003. More than 20 Vanguard funds with $26 billion in assets now track FTSE benchmarks.

Six of Vanguard's international index funds and ETFs will move from MSCI to the FTSE Global Equity Series, including the $67 billion in assets  Vanguard Emerging Markets Stock Index (VEIEX), its  ETF share class (VWO), and the  Vanguard Total International Stock Market Index (VTIAX).

Vanguard didn't say when it will make the switch, only that it will be staggered over "a number of months."

Funds tracking Standard & Poor's and Russell indexes, including  Vanguard 500 Index (VFINX), will not change their benchmarks. Neither will the family's sector index funds and ETFs that track MSCI bogies.

The family will also change the benchmarks of its funds of index funds, including the Target Retirement, LifeStrategy, and Managed Payout series, but leave those offerings' asset allocations alone.

The transition won't trigger capital gains distributions, Vanguard said, but it will incur some short-term transaction costs.