(PUB) Investing 2015

Asia: Hard Pressed to Notice a Difference

Foreign Developed: Small Stocks AddMarginally

Europe: Small Stocks AddedMarginally

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FTSE Developed Asia Pacific Idx. (current bmrk.) FTSE Developed Asia Pacific All Cap Index (new bmrk. w/ sm-cap stocks)

FTSE Developed ex N. America Idx. (current bmrk.) FTSE Developed All Cap ex US Idx. (new bmrk. w/ sm-cap and Canadian stocks )

FTSE Developed Europe Index (current bmrk.) FTSE Developed Europe All Cap Index (new bmrk. w/ sm-cap stocks)

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the “ChinaMiracle” and Chinese stocks, but at the end of the day the addition of a restricted amount of Chinese A-shares just doesn’t move the needle for most investors’ portfolios. If you had 10% of your portfolio in Emerging Markets Stock Index (which is more than most people do), well, five percent of a 10% position is only 0.50%. And the net addition of a 3% position to Chinese stocks means it’s more like a 0.30% change in your portfolio. What’s the big deal? If that doubles or disappears over- night, you’ll be hard-pressed to notice the change, except in the headlines. Small Caps As I mentioned before, Emerging Markets Stock Index isn’t the only foreign stock index fund at Vanguard about to get a new benchmark. Developed Market Index , European Stock Index and Pacific Stock Index will also move to new bogeys in the second half of the year. Again, all the funds are sticking with FTSE as the benchmark arbiter, but are transitioning to broader benchmarks which include small-cap stocks—currently the funds track indexes of large and mid-sized stocks. In addition to picking up small cap- stocks, Developed Markets Index’s new benchmark will include Canada. In order to manage costs, Vanguard plans to take six months or so to build the full 8% position in Canadian stocks in the portfolio. As I said when Total International Stock Index added Canada to its hold- ings, this is small potatoes for inves-

tors. However, by adding Canada to Developed Markets Index, the only thing separating these two index funds will be be Total International Stock’s 18.8% allocation to emerging market stocks. The charts above compare the perfor- mance of each fund’s current and new benchmark over the past dozen years or so—the earliest point for which I could find data. Small-cap stocks would have benefited Developed Market Index, as its new bogey outperformed its current benchmark 155.2% to 143.2% from the end of September 2003 through May 2015. European Stock Index would’ve seen a similar boost in performance by including small-caps stocks, as the new bogey’s 165.5% gain outpaced the current index’s 147.7% return. In the case of Pacific Stock Index, including small-cap stocks would have reduced returns, as the current benchmark out- performed the new index 131.9% to 129.8%—though an investor would be hard-pressed to notice that difference. You can think of differences between the old and new index bogeys as being somewhat akin to the differ- ences between the old index warhorse 500 Index and the newer Total Stock Market Index . Index purists will pre- fer the new bogeys as they are more complete, and Vanguard’s marketing department will have another oppor- tunity to talk up the benefits of broad, broad diversification. Over the long haul, adding small-cap stocks should benefit shareholders’ bottom line, but those extra gains won’t come year-in and year-out, and the investor experi- ence will be very similar. n

May, the fund’s current benchmark index returned 86.3%, while the new benchmark returned 96.0%. Rewind 12 months to the end of May 2014, and the two indexes were even closer in performance, with the current bench- mark up 80.3% versus the new index’s 82.7% gain. It’s taken the massive run in Chinese A-shares over the past year—which some analysts are call- ing a bubble—for investors to start to notice any meaningful difference in performance. Vanguard’s marketing department will get a lot more mileage out of being the first to include A-shares in their index fund than investors will get out of actually owning those shares, since Vanguard can trumpet having the first large emerging markets index fund (or ETF) to include ChineseA-shares. Their top emerging markets index competi- tor, the $30 billion iShares Emerging Markets ETF (EEM), follows an MSCI index that does not currently include Chinese A-shares. That doesn’t mean it won’t, though. MSCI announced in June that it expects to add Chinese A-shares to its index, but is not prepared to do so at this time due to concerns about liquid- ity and the quotas. So, Vanguard will be able to claim to be “first”—for whatev- er that’s worth. (I guess Vanguard isn’t counting the much smaller KraneShares FTSE Emerging Markets Plus ETF, which has under $3 million in assets but launched in February and currently allocates about 20% of its portfolio to Chinese A-Shares.) Plenty of ink has been spilled about

The Independent Adviser for Vanguard Investors • July 2015 • 13

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