Cheaper Indexes, Cheaper Funds

What’s in a benchmark? Fees, apparently. In a move to cut costs and save investors money, Vanguard says it will change the benchmarks it uses for 22 of its index mutual funds and 18 exchange-traded funds.

For six foreign-stock index funds, Vanguard will adopt FTSE benchmarks to replace the current MSCI bogeys. And for 16 of its U.S. stock and balanced funds, it will adopt new indexes from the University of Chicago’s Center for Research in Security Pricing (CRSP).

Vanguard says indexes are simply getting too pricey: The index-licensing fees paid by Vanguard—which are passed on to investors in fund expense ratios—have been rising 50% a year, says chief investment officer Gus Sauter. The new decades-long agreements that Vanguard signed with FTSE and CRSP will save “hundreds of millions of dollars over time,” says Sauter. The transition, which has been two years in the making, will be completed in mid 2013. Over time, Sauter says, expense ratios in the affected funds should drop by 0.01 percentage point or more. Annual fees for Vanguard’s funds average 0.15%, among the industry’s lowest.

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One fund with a new benchmark is Vanguard Total Stock Market Index, a $197 billion behemoth (that figure includes all share classes, including the ETF version). The new benchmark, the CRSP U.S. Total Market index, differs little from the previous MSCI U.S. Broad Market index. The CRSP bogey holds more than 3,700 stocks; MSCI tracks about 3,200.

But bigger differences may emerge in other segments. The FTSE Emerging Market bogey, for instance, excludes South Korea; the MSCI version does not. Other Vanguard funds getting new indexes include the Target Retirement series and Total International Stock Market fund. The changes shouldn’t affect before-fee returns, says Sauter.

Cost is king in indexing, and Vanguard isn’t alone in understanding that. Charles Schwab recently lowered fees on its 15 proprietary ETFs. Schwab U.S. Large-Cap ETF is now the nation’s lowest-cost U.S. stock fund, charging just 0.04% a year. And BlackRock has hinted it may soon lower fees on some of its iShares ETFs.

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