* Vanguard transfer affects index mutual funds, ETFs
* Vanguard says $537 billion of assets will be switched
* MSCI says switch covers $24 million of annual operating
By Aaron Pressman
Oct 2 Vanguard Group, the largest U.S. mutual
fund manager, said on Tuesday it was switching 22 of its biggest
index funds away from benchmarks provided by MSCI Inc
in order to cut costs.
News that one of its biggest index licensing customers had
defected caused shares of MSCI to plunge over 30 percent before
recovering slightly. The shares finished down 27 percent at
$26.21, their lowest in over three years.
Vanguard's move comes as other managers of index funds are
also moving to cut costs. Charles Schwab said last
month that it was trimming fees on its line of exchange-traded
funds to as little as 0.04 percentage points a year while
BlackRock, the top ETF manager, has said it plans to
announce price cuts soon.
Vanguard said it would shift six international stock funds
with $170 billion of assets to track indexes from the FTSE
Group, including its giant Vanguard Emerging Markets Index ETF
. And 16 U.S. stock and balanced funds with $367 billion
of assets, including the Vanguard Total Stock Market ETF
, will switch to indexes developed by the University of
Chicago's Center for Research in Security Prices.
The change affects both mutual funds and exchange-traded
funds, Vanguard, based in Valley Forge, Pennsylvania, said in a
"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," Gus Sauter, chief investment officer at Vanguard,
said in a statement.
MSCI said the switch is expected to be phased-in over a
number of months starting in January 2013 and covers Vanguard
funds that generated annual revenue and operating income of
about $24 million from licensing fees. The New York-based firm
reported operating revenue of $901 million and operating income
of $322 million in 2011.
NOT AS 'STICKY'
But MSCI chief executive Henry Fernandez could do little to
calm investors over fears that other customers might follow
Vanguard's move. MSCI shares, already down over 20 percent in
morning trading, dropped another 5 to 8 percentage points during
a 45-minute conference call Fernandez held with analysts.
ETF managers' choice of index provider "may not be as sticky
as we all thought," Fernandez said on the call. Later, he
explained that despite long-term licensing contracts, ETF
managers could still switch indexes in "relatively short periods
Analysts expect BlackRock, responsible for 8 percent of
MSCI's revenue last year, will likely press for price
reductions. "At the very least, BlackRock will seek to be
competitive with the lower cost target benchmarks that Vanguard
will use, potentially leading to price cuts on its contracts
with MSCI," David Togut, an analyst at Evercore Partners, wrote
in a report on Tuesday.
Still, BlackRock, which has been losing ETF market share to
Vanguard for several years, said it was sticking with MSCI
indexes on its iShares family of funds.
"MSCI is the gold standard of global and international
equity indexes - the near-universal choice of professional
investors," Mark Wiedman, global head of iShares, said in a
statement. "We plan to deepen our partnership with MSCI to help
deliver the highest quality products and portfolio construction
to our clients."
Shares of BlackRock declined 1.5 percent to $177.17. The
firm has already said it plans to cut prices on some ETFs that
compete most directly with large Vanguard funds. Now BlackRock
faces the prospect of Vanguard reducing its fees even more.
Vanguard's decision follows a similar move it made in 2003
to dump higher-cost indexes provided by McGraw-Hill Co's
Standard & Poor's unit in favor of the MSCI benchmarks.
The new indexes may be somewhat inferior at tracking market
results but will lower Vanguard's costs and the savings will be
passed on to investors, said Daniel Wiener, editor of "The
Independent Adviser for Vanguard Investors" newsletter.
"Indexing, particularly through ETFs, is going to get
cheaper and cheaper," Wiener said. "Vanguard is not going to let
someone else, be it Schwab, iShares or any of its other
competitors take the mantle of 'lowest cost' from its
Vanguard officials defended the switch, saying investors
would see little difference. "There's been a real convergence in
index construction methodology over the past decade to a set of
best practices," Joel Dickson, senior ETF strategist at Vanguard
The impact of the change could be felt around the globe, as
the new FTSE index on Vanguard's $67 billion emerging market
fund does not include South Korea, which accounts for over 15
percent of the fund's current MSCI index.
Since FTSE bumped South Korea from its emerging markets
index in September 2009, the MSCI index has posted a slightly
better return, Wiener noted. The FTSE index gained 17.9 percent
versus a gain of 19 percent for the MSCI benchmark.