Earlier this week, Vanguard reopened its International Explorer Fund (VINEX) to new investors. The fund, which focuses on international small-caps, has been closed to new investors since 2004.

VINEX isn't an index mutual fund or exchange-traded fund, which makes it an odd fund for this column to focus on. But a few unique factors make it worth noting.

First, it is a well-established mutual fund run by a shop known for giving managers very short leashes on making big bets.

More importantly, with an expense ratio of just 0.35% a year, VINEX beats all of its current broadly diversified ETF and index fund rivals.

Now that's a switch. Typically, active mutual funds are the more expensive types of investments. But in small-cap international, that hasn't been the case. The first to market among broad-based and highly diversified ETFs was the WisdomTree International SmallCap Dividend Fund (NYSE: DLS). It came out in mid-2006, when VINEX was still closed.

But even though its assets have grown past $300 million, its ER is still some 40% greater than the venerable mutual fund, charging 0.58% in expenses. WisdomTree has pointed out that dividend-based funds are different than traditional market-cap-weighted ETFs in defending its existing pricing structures. But can such marketing logic prevail now that VINEX is back in the fold? After all, it seems something of a stretch to argue that running a portfolio based on screening by dividend streams is more expensive than running a truly actively managed mutual fund.

One of WisdomTree's chief rivals, index creator Research Affiliates, also takes a nontraditional market-cap approach to building portfolios. Its fundamentally weighted benchmarks are tied in to a number of ETFs, including the PowerShares FTSI RAFI Developed Markets ex-U.S. Small-Mid Portfolio (NYSE: PDN). Curiously, on the same day that VINEX was reopening, PowerShares slashed ERs on 11 of its Research Affiliates-linked ETFs, to a uniform 0.39%. An exception was PDN, which remains at 0.75%.

WisdomTree and PowerShares aren't the only ETF sponsors facing increased pricing pressures in small-cap international waters. Although a total of 11 different ETFs can claim a portion of the field by targeting more specialized markets or distinct niches, five funds compete directly among broadly diversified portfolios.

Below is a brief comparison of the broadest low-cost ETFs available directly to retail investors, with VINEX thrown into the mix. Since all but one of the ETFs launched last year (with the oldest not even reaching age 3 yet), performance data is represented by each fund's underlying index returns through the third quarter. The exception is VINEX, which has been around under various managers since late 1996. ETF assets are through Wednesday.

*Total assets at the time of VINEX's reopening on Nov. 1

A number of caveats pop up when looking at the competitive landscape of these small-cap international stock funds. For one, VINEX requires an initial investment of $25,000. It also charges redemption fees of 2% on assets held less than two months. After that time, it's certainly possible to keep less than $25,000 in the fund, although Vanguard probably wouldn't appreciate such a move.

(Anyone with $100,000 or more in combined assets with Vanguard faces fewer restrictions on minimum asset levels, although it's probably wise to keep at least $500 in a fund regardless of your position.)

With an expense ratio of 0.40%, just 0.05% more than VINEX, the iShares MSCI EAFE Small Cap Index (NYSEArca: SCZ) offers an attractive low-cost alternative. But it doesn't provide emerging markets exposure, which VINEX does to a limited degree (less than 10% of the fund's total assets through the third quarter.)

The other question is how much does the increased risks associated with active management mean to you? For those of us old enough to remember, VINEX was a laggard when it first got started. That changed when Schroders Investment Management took over in 2000. But that also meant a tweaking of strategies and changes in the underlying portfolio.

Asset bloat has also arguably been a problem for this fund. It closed in 2004 with $1.4 billion in assets and reopened after a nasty market this year cut that down to slightly more than $1 billion. That still could be a hefty amount for a manager to handle in often-illiquid small-cap foreign markets.

And consider the differences in annual turnover ratios: SZC is listed at 15% with 600-plus names; GXW at 5% and more than 500 stocks; and VINEX at 45% turnover with nearly 200 stocks.

"The historical long-term returns are great for VINEX when compared against small-cap international indexes," said Kyle Waller, research analyst at Wiser Wealth Management. "However, since ETFs started coming out in the past two years in that asset class, VINEX's performance has tracked fairly closely to its index-based competition."

In the past 12 months, index returns have varied in the group by slightly more than 4 percentage points. Over longer periods, SCZ has lagged DLS—the best performer in the past five years heading into the fourth quarter—by just north of 2 percentage points. VINEX fell in the middle of the pack.

For a more detailed breakdown of small-cap international stock ETFs, see an analysis from February's ETF Report here. (The magazine requires a subscription; a less-detailed version free to IU.com readers can be found here.)

Finally, there's the age-old question of how well the team running VINEX will continue to hold up. At the end of last year, one of its managers left and an analyst was promoted to replace him.

Future Alpha? 

"It's hard to determine why and if the managers of VINEX will continue to produce alpha in the future," said Waller. "We shy away from active mutual funds in general, regardless of the cost issues, because they just don't have the transparency of index-based ETFs."

Richard Kang, a well-known industry consultant, puts it another way. "From my own experience, I've learned that the problem with active mutual funds is that the moment Richard Kang decides to make a purchase, they start doing poorly," he said with a laugh.

Kang agrees, though, that the prospects of a renowned shop like Vanguard opening an active mutual fund that can undercut rival ETFs' costs probably sounds attractive to a lot of investors.  

But he cautions against equating alpha with skill.

Alpha refers to the added return a manager brings above the market's general trend of long-term upward movement. It's one way to measure a fund's returns and often is compared to beta, which purely provides a metric for showing how much of a portfolio's return is coming strictly from broader macro currents.

"Since beta is determined by the market, alpha represents a fund's performance minus the market. Most people associate that with a manager's ability to pick stocks," said Kang.

More Than Skill Involved 

But he argues that's a bit simplistic. "The truth is, according to statistics provided from studies of modern portfolio theory, alpha's not just about skill levels. It's also about fees, which aren't determined by the market—they're set by the manager," said Kang.

Vanguard has made a conscious decision to offer an active fund with lower fees, he points out. "That helps the manager, but it doesn't necessarily have an impact on markets or help investors," said Kang.

Just a point in terms of full disclosure: I currently own VINEX and have owned GWX as well as SCZ in the past. I'm definitely in the camp that small-cap international is an important asset class with distinct characteristics.

I'd also like to point out that my situation is different from most others. The reason for me picking one fund over another has as much to do with issues such as fund availability in various retirement accounts and contribution limits as anything else.

In my mind, at least, the more alternatives on the market, the better. Along those lines, the reopening of VINEX poses some interesting new competition in the ETF market and hopefully will result in lower-costing choices in small-cap international stock funds.

But the question remains: Are low expenses for ETFs the chief attraction for most people? As mutual funds continue to bleed assets, it's possible their pricing structures will eventually fall in some sort of significant manner.

Is the ETF industry up to the task? And more importantly, will they keep delivering for investors?

Murray Coleman is managing editor at IndexUniverse.com. He welcomes comments at: This e-mail address is being protected from spambots. You need JavaScript enabled to view it