Vanguard ETF/fund ratios

Vanguard began offering exchange traded funds in 2001. Vanguard ETFs are structured as separate share classes of mutual fund portfolios. Since inception, the firm has experienced steady growth of ETF assets. Vanguard is now the third largest U.S. ETF provider (behind Blackrock/ishares and State Street Global Advisors). The following table shows Vanguard ETF asset levels over the 2008 to 2011 period.

The dual structure of Vanguard ETFs provides the investment manager with multiple techniques for handling tax-management issues and helps reduce fund transaction costs:

''Because Vanguard ETFs are shares of conventional Vanguard index funds, they can take full advantage of tax-management strategies available to conventional funds and to ETFs. Conventional index funds can manage tax liabilities by selling high-cost securities to realize losses to offset realized gains. They can also limit a fund's potential capital gains exposure by using in-kind redemptions to eliminate stocks with high built-in capital gains from the portfolio. This advantage gives our Vanguard ETFs management team more flexibility in implementing tax-management strategies.'' (from Learn More About Vanguard ETFs}

Shareholder transactions (purchases and redemptions) in mutual fund shares impose transaction costs on fund shareholders as the fund manager buys or sells securities with these fund flows. In the case of selling, the fund realizes a taxable gain or loss depending on the cost basis of the shares sold.

Individual shareholder transactions (purchases and sales) in ETF shares are made on brokerages; no transaction costs are incurred by the fund portfolio. Direct purchases and redemptions in the fund portfolio are made by institutional investors during the creation/redemption process. These are in-kind security transfers. Once again, the fund pays little or no transaction costs for in-kind exchanges (the transaction costs are borne by the institutional investor.) In-kind redemption gains are not taxable. By selecting the lowest basis shares for such transfers, the fund manager can transfer the embedded capital appreciation tax liability from the portfolio.



The following table records the percentage of ETF shares to the total shares of each Vanguard Equity Index Fund offering ETF shares. For long term data on Vanguard fund tax efficiency and shareholder turnover, please refer to the pages included in the Vanguard Funds navigational box included below.

Table 2.

Notes:
 * 1) Ratios are determined at the close of the calendar years (12/31). For international index funds (except for the MSCI EAFE fund), the calculations prior to 2009 are made at the close of the fiscal year (10/31).