Exchange-Traded Funds Go Mainstream
May 22, 2000
The Vanguard Group's decision to issue a new exchange-traded share class on six of its index funds represents a milestone in the evolution of exchange-traded funds and will popularize them with investors interested in short-term trading and fund companies interested in offering them, said mutual fund executives.
"My guess is Vanguard's share class will add more momentum to a trend that was already well established by Standard & Poor's Depository Receipts, World Equity Benchmark Shares and Holding Company Depository Receipts," said Loren Fleckenstein, editor-in-chief of FundMovers.com, a website based in Los Angeles dedicated to mutual fund market timing.
Exchange-traded funds are routinely used by market timers and momentum investors to employ short-term trading tactics.
Vanguard's decision to issue a share class designed for short-term trading contrasts with the company's traditional buy-and-hold approach to mutual fund investing as well as recent statements made by company executives.
"As an industry, it's up to us to lay out tried and true strategies of investing," said Jack Brennan, chairman of the ICI board of governors and CEO and chairman of the Vanguard Group of Malvern, Pa., at an ICI luncheon in March. "As we move into a new century, we as an industry need to encourage prudent investing."
And in a speech in December, John Bogle, Vanguard's founder and former senior chairman, said exchange-traded shares are incongruous with Vanguard's investing philosophy.
"What is wrong is that this new breed of index funds, by accident or design, seems to be frustrating the original purpose of the index strategy - efficient long-term investing in a diversified portfolio of businesses - giving us instead a vehicle for short-term speculation in the stock market," Bogle said. Bogle resigned from Vanguard on Dec. 31, 1999.
Calls to the Vanguard Group seeking comment were not returned.
The addition of the new share class, named Vanguard Index Participation Equity Receipts, or, VIPERS, is part of a company strategy to draw market timers out of their existing funds, according to a statement Vanguard issued May 12.
"The addition of the VIPER shares is expected to have no immediate impact on existing fund shareholders," the statement said. "Vanguard believes though that, over time, existing fund shareholders will benefit from a reduction of the deleterious effects of short-term investors who are likely to be attracted to the VIPER shares and away from the traditional shares."
The new share class will be attached to the Vanguard 500 Index Fund, Total Stock Market Index Fund, Vanguard Small-Cap Index Fund, Vanguard Growth Index Fund and the Vanguard Value Index Fund.
The company has filed an application seeking an exemption from the Investment Company Act of 1940 that would allow an exchange-traded share class to be attached to the funds. The company has not determined fees for the funds, according to the statement.
Vanguard's decision to issue the first exchange-traded share class serves as a stamp of approval for exchange-traded funds and will motivate other fund companies to offer them, said Gary Gastineau, managing director of structured investments for John Nuveen Co. of Chicago. Gastineau was formerly senior vice president for product development at the American Stock Exchange. While exchange-traded funds have grown in popularity, the Investment Company Institute has not embraced them, Gastineau has said. (MFMN 3/20/00)
Although exchange-traded funds attract market-timers, Vanguard's decision to provide a short-term trading vehicle does not conflict with its buy-and-hold philosophy because the firm hopes to use the share class to protect long-term investors from hot money moving in and out of its index funds, Gastineau said.
The VIPER share class may also be a way for Vanguard to accommodate more than just long-term investors, said Kathleen H. Moriarty, a financial products and securities lawyer with Carter, Ledyard & Milburn of New York.