Vanguard FTSE Switch to Boost China as Korean Stocks Sold

Vanguard Group Inc. fund managers investing in emerging markets will have to sell South Korean stocks and step up purchases of Chinese and Brazilian shares after the largest U.S. mutual-fund provider switched benchmarks for its six equity funds.

FTSE Group’s Emerging Index, which excludes South Korea as it’s classed as a developed market, will replace MSCI Inc. (MSCI)’s Emerging Markets Index as the reference gauge for the Vanguard Emerging Markets Stock Index Fund, the Valley Forge, Pennsylvania-based firm said yesterday. The $67 billion fund will need to boost investment in equities of Brazil, South Africa, China, India and Taiwan as they are weighted higher in FTSE’s index than in MSCI’s, data compiled by Bloomberg show.

“This change will have an impact on asset allocation for these fund managers,” said Nader Naeimi, the Sydney-based head of dynamic asset allocation at AMP Capital Investors Ltd., which manages almost $100 billion. “If Korea becomes developed status then they’re going to have to get money out.”

The Vanguard Emerging Markets Stock Index and its ETF currently invest 15.5 percent of their money, or $10 billion, in South Korea, according to data compiled by Bloomberg on the MSCI Emerging Markets Index. (MXEF)

Those outflows will be partly offset by new investments in South Korean stocks from the Developed Markets Index Fund, the Pacific Stock Index Fund and the Tax-Managed International Fund, the data show. The Asian nation’s stocks are 2.3 percent of the FTSE World Index of developed market shares.

Tracker Funds

Six Vanguard international index funds will transition to benchmarks in the FTSE Global Equity Index Series as the firm seeks lower expense ratios and better returns, Vanguard said in yesterday’s statement.

Money managers of so-called tracker funds can’t own shares that are listed in a country not covered under its benchmark. Vanguard’s emerging markets fund will need to sell positions in South Korean stocks to comply with the shift to FTSE, said Julie Andrews, a director in Australia for FTSE Group.

The FTSE emerging markets gauge weights Brazilian stocks 16.1 percent, compared with 12.6 percent on the MSCI index. South Africa makes up 10.6 percent of FTSE’s index and 7.7 percent of the MSCI benchmark, while China is 16.7 percent of the FTSE and 12.9 percent on the MSCI. India comprises 9.6 percent of FTSE’s emerging markets index and has a weighting of 7.1 percent on MSCI’s, while Taiwan makes up 13.2 percent of the FTSE gauge versus 11 percent at MSCI.

Mimic Moves

The switch to FTSE gauges is the largest ever transition in international index providers, according to the FTSE statement released yesterday. Shares of MSCI had a record 27 percent slide in New York yesterday.

Vanguard, known for its low-cost index tracker funds, manages about $1.95 trillion in U.S. mutual fund assets. The change will affect both index mutual funds and exchange-traded funds at Vanguard, whose ETFs are structured as share classes of its mutual funds.

The $58 billion Vanguard MSCI Emerging Markets ETF (VWO) had 13 percent of its allocation in South Korea shares at the end of June, according to data compiled by Bloomberg. The ETF trades throughout the U.S. day and is designed to mimic moves in MSCI benchmark indexes without trying to outperform the gauge. Vanguard’s Developed Markets Index Fund is worth $11.3 billion, more than 70 percent below the value of the emerging markets ETF, according to FTSE Group.

South Korea’s KOSPI Index (KOSPI), which was closed for a holiday today, has gained 9.3 percent in 2012.

U.A.E. Stocks

Equities from the United Arab Emirates, deemed a frontier market by MSCI, may also benefit from Vanguard’s move as they are regarded as emerging by FTSE.

Stocks from the U.A.E. make up 0.34 percent of FTSE’s emerging markets index, while the weighting for Egypt, the world’s best performing market this year, is 0.51 percent, according to FTSE’s website. Egypt makes up 0.36 percent of MSCI’s emerging markets gauge, data compiled by Bloomberg show.

Benchmark indexes in Dubai, Abu Dhabi and Egypt rose today, with the DFM General Index (DFMGI) soaring to the highest level in five months and Egypt’s EGX 30 Index climbing 0.8 percent, gaining for the first time in five days. UAE companies contribute $11.5 billion to the FTSE index and account for 10 of the 793 stocks while Egypt, which contributes 13 stocks, is valued at $17.3 billion.

‘Positive Factor’

“The news that one of the largest emerging-market exchange-traded funds is switching to the FTSE index series is a positive factor for both the U.A.E. and Egypt,” Julian Bruce, the Dubai-based director of institutional sales trading at EFG- Hermes Holding SAE, said by e-mail today. “Timing remains uncertain but this type of event is always a catalyst for increased speculative activity.”

Vanguard’s switch comes as trading volumes in Dubai drop amid the European debt crisis and threat of a global slowdown.

About 228 million shares traded in Dubai today, down from a March peak of 835 million. U.A.E. equities are valued at $108 billion and those in Egypt at $69 billion, according to data compiled by Bloomberg. The U.A.E. failed for a fourth year in June to secure an upgrade from MSCI to emerging-market status, after the New York-based index provider cited issues with market accessibility.

The Vanguard Total Stock Market Index fund, the firm’s largest index fund at $197 billion, will track the CRSP U.S. Total Market Index instead of the MSCI U.S. Broad Market Index, Vanguard said yesterday. There is no difference in what MSCI and FTSE consider developed markets in western Europe.

Nestle Weighting

Individual stocks may see changes in investment flows as a result of their different weightings in the benchmarks. Nestle SA (NESN), the world’s largest food company, makes up 0.77 percent of the 2,463-member FTSE World Index (FTWI01), less than its 0.83 percent weighting in the MSCI World Index (MXWO), which has 1,626 members, data compiled by Bloomberg show. U.K. bank HSBC Holdings Plc (HSBA) makes up 0.68 percent of the MSCI benchmark to 0.6 percent of the FTSE gauge.

“Free-float factors are not the same for both indices, this might create some differences for a few stocks,” Christophe Wakim, an analyst at Exane BNP Paribas in Paris, said in a phone interview. “The only thing we don’t know is how they want to do the migration. If they do it in a clever way, they should be able to have a smooth and progressive transition that will have very limited impact.”

Vanguard will migrate 16 U.S. stock and balanced-index funds to new benchmarks developed by the University of Chicago’s Center for Research in Security Prices, according to yesterday’s statement.

MSCI gained today, after yesterday’s 27 percent slump. The shares added 7.1 percent to $28.08 by 3:08 p.m. in New York.

To contact the reporters on this story: Zahra Hankir in Dubai at zhankir@bloomberg.net; Adam Haigh in Sydney at ahaigh1@bloomberg.net

To contact the editor responsible for this story: Claudia Maedler at cmaedler@bloomberg.net

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