Vanguard Adds Mainland China Exposure - Adviser Investments

Vanguard Adds Mainland China Exposure

Vanguard Adds International Small-Cap and Chinese Exposure

At the beginning of June, Vanguard announced that over the next 18 months or so, four of its international equity index funds and ETFs will add small-cap exposure to their portfolios as they transition to more broadly defined all-cap FTSE benchmarks sometime in the third or fourth quarter of 2015.

Vanguard Chairman and CEO Bill McNabb said the move is intended to further diversify stock holdings and better achieve comprehensive and complete market coverage.

Small-cap stocks will become a part of Vanguard’s Emerging Markets Stock Index, Developed Markets Index, European Stock Index and Pacific Index funds, putting them nearer to actual global market-cap weightings. Developed Markets Index will also be adding exposure to Canadian companies, while Emerging Markets Stock Index will include China A-shares (which we’ll discuss below). Small-caps account for between 9% and 11% of each fund’s new benchmark. Expense ratios aren’t expected to change.

In an effort to save on costs and streamline the change, Emerging Markets Index and Developed Markets Index will benchmark to transition indexes that will be updated monthly for approximately 12 months and six months, respectively.

Fund/ETF Current Benchmark Transition Benchmark New Benchmark
Emerging Markets Stock Index FTSE Emerging Index FTSE Emerging Markets All Cap China A Inclusion Transition Index FTSE Emerging Markets All Cap China A Inclusion Index
Developed Markets Index FTSE Developed ex North America Index FTSE Developed All Cap ex US Transition Index FTSE Developed All Cap ex US Index
European Stock Index FTSE Developed Europe Index FTSE Developed Europe All Cap Index
Pacific Stock Index FTSE Developed Asia Pacific Index FTSE Developed Asia Pacific All Cap Index

Source: Vanguard.


Emerging Markets Stock Index Adds China Exposure

The announcement garnered headlines mainly because Vanguard Emerging Markets Stock Index will become the first major emerging markets fund to add exposure to Chinese A-shares stocks listed on the Shanghai and Shenzhen exchanges.

Investors have been waiting for the inclusion of A-shares in emerging markets indexes for some time, but a review of Vanguard’s benchmark changes on the impact of portfolios and performances don’t seem to match the hype. For most investors, who only dabble in emerging markets, the impact will be negligible at best.

Given the marginal effect on portfolios, why all the excitement? Historically, foreign investors have been unable to hold A-shares, though the Chinese government has recently allowed certain foreign investors to buy a limited, proscribed amount.

Beginning later this year, the Vanguard fund will start its shift to the new index. Once completed, small-caps will account for about 10% of Emerging Markets Stock Index, with Chinese A-shares amounting to 5.6% of the benchmark index tracked by the fund.

Emerging Markets Stock Index currently has a 29% allocation to Chinese equities via the Hong Kong stock market. By the end of 2016, the fund’s portfolio will be about 26% Hong Kong-listed stocks—add on the new A-shares exposure and you get a total of around 32% allocated to China, just a 3% increase overall. The Hong Kong-based Chinese equities will get a smaller weight in the benchmark, but the fund’s complexion isn’t going through a massive change.

Think of it this way: If you had 10% of your portfolio in Vanguard’s Emerging Markets Stock Index (which is more than most people do), 5.6% of a 10% position is only 0.56% of the total portfolio. The net addition of a 3% position to Chinese stocks would be a mere 0.3% change in your portfolio. If a portion that small doubles or disappears overnight you’d hardly notice. But it does make for eye-catching headlines.

We think most investors in the four funds affected by the changes won’t notice much of a difference in portfolio composition or performance, especially since the changes will be gradual.

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