Vanguard’s Me-Too ETFs: Good Or Bad?
July 01, 2010
Don Dion of TheStreet.com argues today that Vanguard’s decision to launch S&P and Russell ETFs are essentially bad for investors.
To summarize, his argument is essentially that Vanguard’s new ETFs will be redundant with existing offerings from both Vanguard itself and from competitors like BlackRock and State Street.
“[A]side from being able to tack on the S&P and Russell name on their new funds, there doesn't appear to be much added benefit to investors in launching these products,” Dion writes.
I’m not so sure I agree.
Dion seems to be worried that Vanguard investors will accidentally purchase both the Vanguard Large Cap ETF (NYSEArca: VV) and the new Vanguard S&P 500 ETF, and thereby double up on exposure. While you can never underestimate the capability of investors to make mistakes, this seems extraordinarily unlikely. Investors already have a lot of choices in the ETF space—there are, for instance, 42 large-cap ETFs—and we don’t seem to worry about investors mixing large-cap funds from iShares with similar funds from State Street.
A more legitimate concern is that Vanguard will fracture the liquidity that exists in its core MSCI-based product lines, and that, rather than having one set of highly liquid ETFs, it will divide that liquidity across multiple products and investors will end up paying higher trading costs in terms of spreads, premiums/discounts and market impact.
This is a legitimate theoretical concern, and we’ll have to see how it plays out. But other companies have succeeded at having multiple liquid ETFs covering the same asset class. iShares, for instance, has $5 billion in the iShares Russell 1000 ETF (NYSEArca: IWB), $21 billion in the iShares S&P 500 ETF (NYSEArca: IVV) and $220 million in the iShares Morningstar Large Cap Core (NYSEArca: JKD) ETFs. Investors don’t seem to be suffering there.
Investors like having choice in index families—many advisers have serious and well-founded opinions about which index family is better—and the ETF industry can cater to those needs. Last time I checked, choice was almost always an unmitigated good in investing, unless you assume that investors are idiots who need to be coddled.
In the end, Dion’s main point (I think) is that investors should be more or less satisfied with the large-cap ETFs that exist. Let me take the opposite side of that argument. There are a lot of things that Vanguard does well, and having them push the envelope in terms of quality will help improve this industry further.
The point that the media tends to focus on—lower costs—is just one piece of it.
Another big piece is that Vanguard returns all the revenue from security lending in its funds to its investors, while iShares splits it 50/50 between investors and the company (and many other issuers don’t even disclose how they divide revenue).
Further, due to Vanguard’s unique hub-and-spoke structure, in some cases they’ve provided better quality index coverage than their competitors.
The storied battle between iShares Emerging Markets ETF (NYSEArca: EEM) and Vanguard’s (NYSEArca: VWO) is the clearest example. Because Vanguard ETFs are actually share classes of much larger portfolios, they’ve been able to pursue full replication of tricky indexes like the MSCI Emerging Markets index. That’s given Vanguard a 3.5 percent performance edge over the past 12 months—a noteworthy difference between two funds that most folks would assume are identical.
And that competition makes everyone stronger. EEM is a better fund today—with 619 securities in it—than it was a few years ago, when it would regularly have just a few hundred representative emerging markets stocks in the portfolio.
It’s not that Vanguard’s funds are always better—they’re not—but the company does push some investor-friendly best practices that can improve things for all investors. And that’s why I like having them in the game. And I think investors are smart enough to decide for themselves whether they’re looking for French Vanilla or Slow-Churn Vanilla when comparison shopping, even in the most basic asset classes.