(PUB) Investing 2016

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12 • Fund Family Shareholder Association
stocks for the long term makes good
portfolio sense.
This is the perfect time, then, to
review Vanguard’s lineup of foreign
stock funds, a host of rather basic
offerings, with a slew of overlapping
index funds and a handful of active
funds. While developed and emerging
markets are well represented, frontier
markets, home to riskier but potentially
faster-growing fare, haven’t made it
onto Vanguard’s list yet. I don’t expect
to see them soon, either. With over $3
trillion in assets under management, it
takes a large opportunity to move the
needle for Vanguard, and the small size
and limited liquidity of frontier markets
don’t offer much motivation to launch a
new product.
In fact, there hasn’t been much
excitement surrounding Vanguard’s
foreign lineup, save for the addition of
smaller stocks to its core index funds,
along with a growing allocation to
mainland China A-shares in Emerging
Markets Stock Index. While it raised a
lot of eyebrows when first announced,
the China news has fallen from inves-
tors’ radars. This is just as well. As Dan
and I wrote in the July 2015 issue, for
all the noise this change generated, the
impact was pretty small.
Last month we talked a lot about
investing overseas and whether it
makes sense to conform to Vanguard’s
recommended 40% (of equities) allo-
cation to foreign stocks at all times or
to allow the markets and your head and
stomach to determine an appropriate
allocation.
One thing we didn’t discuss was
the actual funds themselves. So, let’s
do that. But first, I want to mention
something called “fair-value pricing,”
which is the day-to-day manipula-
tion of mutual fund prices (not ETF
prices) that Vanguard engages in (as
required by the SEC) to prevent inves-
tors from leaping ahead of news events
that may cause market moves in time
zones many hours different from our
own. Investors might, for instance,
try to trade Pacific Index, which has
about 60% of its assets allocated to
Japanese stocks and another 25% or so
in Australian and Korean stocks, when
those markets are closed and there is
major market-moving news occurring
in those countries while U.S. markets
remain open.
The difference between the price
of a fund’s regular shares and its ETF
shares can sometimes tell the tale of a
Vanguard intervention. For instance,
Emerging Markets Stock Index’s daily
return and the return of its ETF shares
have varied by as much as 1.0% to
2.2% on a handful of days since the start
of the year. Differences between ETF
and open-end fund performance tend to
even out within a day or two, and unless
you’re trading in and out of the open-
end fund, which Vanguard will quickly
put a stop to, I wouldn’t lose a wink of
sleep over fair-value pricing.
With all of that said, and with July’s
primer on investing overseas as backup,
here’s where Vanguard stakes its for-
eign investing claims, and where Dan
and I suggest you focus your purchases.
Developed Markets Index
Sell. Once a fund of funds,
Developed Markets Index now holds
individual stocks, just like the rest
of Vanguard’s foreign funds. While
the benchmark the fund tracks has
changed over time, and completed its
latest transition in June, the fund’s
mission remains the same: Track a
broad set of stocks from established
foreign markets. The new index the
fund tracks, the FTSE Developed All
Cap ex-U.S. index, includes smaller
stocks as well as Canadian stocks,
something the fund did not hold in
previous incarnations. Based on his-
torical data, these additions added to
performance over time, though vola-
tility also increased. As you might
expect, Developed Markets Index does
not hold stocks from emerging market
countries, which you will find in other
index funds like Total International
Stock Index, Total World Stock
Index or World ex-U.S. Index. And
there’s the rub. If you buy into the
indexers’ credo that one should index
“all” markets rather than a slice of the
pie, then this fund is a non-starter.
Emerging Markets Stock Index
Hold. Also proceeding towards a
new benchmark, the FTSE Emerging
Markets All Cap China A Inclusion
index, this fund is unique in making
a foray into the volatile and opaque
A-shares market of mainland China.
Vanguard has already said that it’s
going to have to deviate from the
index by “sampling” rather than “rep-
licating,” and this new index will be a
moving target due to the limits that the
Chinese government puts on foreign
entities’ ownership of A-shares. Still,
this isn’t as big a change as the press
would have you believe. While the
small caps being added to this fund
should increase volatility, exposure to
China should only grow by about 3%
from where it stood a year ago, to 30%.
Additionally, Vanguard is taking its
time implementing this change and has
been tracking a “transition” index since
last November. The conversion should
be completed in the fall.
The emerging markets are consid-
ered a global growth engine, but they’re
also riskier than mainstream domestic
markets. And China’s slowdown, which
was big news at the start of this year but
has taken a back seat to terrorism and
politics, begs the question of whether
the risk-return balance favors returns
as much today and tomorrow as it has
in the past.
More broadly speaking, are the
large-cap domestic companies you
own today already giving you enough
exposure to emerging markets through
their global operations, or do you need
direct exposure to companies in these
regions? I lean toward the latter, and a
fund like International Growth gives
us good exposure. A small allocation
to emerging markets makes sense, as
there will always be local companies
that will understand and be able to take
advantage of local markets in a fashion
the bigger global conglomerates won’t.
Additionally, while it may feel like
stocks across the globe all move in the
same direction on a day-to-day basis,
in fact, emerging market stocks can be
good diversifiers over time. Consider
that from the end of 1999 through 2007,
Emerging Markets Stock Index gained
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