Vanguard Total World (VT) not fully replicates its benchmark

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MekongTrader
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Vanguard Total World (VT) not fully replicates its benchmark

Post by MekongTrader » Tue Dec 04, 2012 3:13 am

Hello,
I consider buying some VT because of its diversification. In Dec 2011 Vanguard had announced that they will include small-caps and the new benchmark would be FTSE Global All Cap Index. The benchmark index contains over 7'200 stocks but VT so far only 3'800 stocks (as per VG website).

My question: Why doesn't VT fully replicate its benchmark?

Thanks,

MT

jjbiv
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Re: Vanguard Total World (VT) not fully replicates its bench

Post by jjbiv » Tue Dec 04, 2012 8:40 am

Total World uses representative sampling to track its index instead of holding all of the elements of the index. This is likely due to the fund's lack of scale and desire to keep costs relatively low. The fund is relatively new and has ~$2 billion in assets -- about 1% of the size of TSM. You could almost as easily use a mix of Total Stock Market and Total International Stock to replicate Total World (this mix would also include some additional holdings for additional diversification).

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nisiprius
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Re: Vanguard Total World (VT) not fully replicates its bench

Post by nisiprius » Tue Dec 04, 2012 8:46 am

"Vanguard Total World Stock Index Fund seeks to track the performance of a benchmark index that measures the investment return of global stocks." It doesn't say it will do this by holding every stock in the index. The Prospectus for the fund says plainly enough:
Indexing Strategy. The Fund uses a sampling method of indexing, meaning that the Fund’s advisor, using sophisticated computer programs, selects from the target index a representative sample of securities that will resemble the target index in terms of key risk factors and other characteristics. These factors include industry weightings, country weightings, market capitalization, and other financial characteristics of stocks.

The Fund is subject to index sampling risk, which is the chance that the securities selected for the Fund, in the aggregate, will not provide investment performance matching that of the Fund’s target index. Index sampling risk for the Fund should be low.


When the Vanguard 500 Index fund was first introduced, they didn't have enough money for it to be practical to purchase all 500 stocks in the index, so they purchased a representative sample of about half of them. These days it's feasible for a mutual fund to own all the stocks in the S&P 500, because electronic trading has driven costs down, because the funds themselves are big enough that their transaction costs can be a small percentage of the stocks' prices, and because all of the companies are big enough that Vanguard can purchase millions of dollars' worth of the stock without driving the price up.

For international stocks and small-caps there are still apparently transaction cost issues. Even if it were feasible, index funds sometimes use derivatives and various active-management techniques to overcome costs so as to track the index more closely.
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MekongTrader
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Re: Vanguard Total World (VT) not fully replicates its bench

Post by MekongTrader » Wed Dec 05, 2012 2:05 am

Thanks for the feed back and explanation.
MT

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Re: Vanguard Total World (VT) not fully replicates its bench

Post by datamonkee » Wed Dec 05, 2012 8:16 am

Would the tracking be better if Vanguard holds VXUS and VTI?

Maybe the expense ratio would be lower too. That's always been the thing holding me back from buy VT, but I love the idea of VT.

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