Indexing

Vanguard FTSE All-World ex USA Index

According to this post on the “Diehards in the Vanguard” forum, the Vanguard FTSE All-World ex USA index funds and ETF will start trading soon. This information comes from the SEC filing here.

For the mutual fund version (ticker VFWIX), the expense ratio is 0.40%, with a purchase fee of 0.25%, and a redemption fee of 2% if sold within two months. The expected date of offering is March 8, 2007.

For the ETF version (ticker VEU), the expense ratio is 0.25%. The expected date of offering is March 2, 2007. Usual brokerage fees apply if you do not have access to a free trade program.

The mutual fund version, with the purchase fee is not appealing to me at all but the ETF version does. Compared to the iShares MSCI EAFE ETF (ticker EFA, ER 0.35%), this new ETF would cover the equity market of the entire world except the US. This means that it also includes Canada and emerging markets which EFA doesn’t. In addition, it also comes with a lower price tag than EFA.

Hopefully, this fund would have a respectable trading volume when it debuts on Friday.

Morningstar Indexes Yearbook 2005

Barry’s Financial Page alerted me to the latest edition of the Morningstar Indexes Yearbook 2005. The following are some excerpts from the year book.

Don Phillips, managing director at Morningstar, offers his insight on whether market-cap weighted indexes serve investors’ best interests. He also discusses the risks associated with today’s specialized indexes and what steps providers can take to moderate those risks:

The bottom line is this; the index community is at a crossroads. It’s wandered so far from its roots of offering one-stop, broad-based exposure to the market that a return to that simpler approach may not be possible. In creating more complex offerings, the index community has found new revenue sources from hedge funds and other parties seeking very specialized tools, but it has done so at the risk of doing considerable harm to less sophisticated investors. The test of character facing the index community is whether it ignores that risk or steps up and tries to mitigate it.

Morningstar director of mutual fund research, Russel Kinnel, examines the role indexing plays in active and passive investing strategies. All too often, he says, the industry uses an incorrect proxy for indexing that can lead to the wrong conclusions:

For the trailing three years ending 2005, fewer than one-third of small-cap U.S. stock funds beat their respective Morningstar Index. Meanwhile, more than half of large-cap U.S. stock funds beat their respective index.

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Index returns from July 1997 through January 2006 are shown below:

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I particularly think that the following statements make a lot of sense for investors when selecting mutual funds:

Our studies have shown that lower-cost funds—regardless of whether they are active or passive—are a good bet. Maybe small caps really are less efficient than large caps despite what these figures show, but on another level, it doesn’t really matter. Either way, lower-cost funds are the way to go, and investors ought to do well whether they choose active or passive funds. And of course, investors can do better by focusing on other fundamentals, too, such as management, strategy, and asset size. When choosing an index fund, investors should look for one with low turnover, low costs, and a diversified portfolio.

Breakeven point for an investment in S&P500 index

The recent highs of the Dow Jones Industrials Average prompted me to look into whether a lump-sum investment at the peak of the S&P 500 has reached the breakeven point. According to data from Yahoo finance, the S&P 500 reached its last peak on Mar 24, 2000, with a value of 1527.46 and the closing value of the S&P 500 on Oct 6, 2006 was 1349.59. This means that the ‘raw’ index has only reached 1349.59 / 1527.46 = 88.4% of its 2000 peak. It appears that there is more than 10% to go before the breakeven point is reached.

However, since the ‘raw’ index does not include dividends, the above conclusion is incorrect; we need to include dividends. To do this, and to use an investment easily understood and reproducible by investors (as opposed to just a hypothetical investment), I shall use the popular SPY ETF (expense ratio 0.10%) as a proxy for the actual investment returns obtainable by an investor if it were held in a tax-deferred account.

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Using data from Yahoo finance, the “adjusted close” value (“adjusted close” means that the value is adjusted for dividend distributions) of SPY on Mar 24, 2000 was $139.23. The most recent closing value of SPY (Oct 6, 2006) was $135.01, or roughly 97% of the peak. This means that the breakeven point for a lump-sum investment in the S&P 500 made on Mar 24, 2000, will be reached if the index rises by another 3% or so.

The effect of dividend distributions can be observed in the attached figure. In the figure, the ‘raw’ index values (in blue) are given on the left axis and superimposed on the right axis are the ‘dividend-adjusted’ values of the SPY ETF (in green). We can see that dividend distributions have significant effect on the returns of the investment. These should never be ignored when comparing an investment’s performance with a given index.