The Vanguard Group Inc.'s unexpected announcement this week that it will add exposure to China's high-flying but tightly regulated onshore markets accelerates competition among fund sponsors to provide investors with the broadest exposure to global markets.
The firm, the largest U.S. mutual fund company, said Tuesday it would add exposure to China's vast “A share” market to its $68.7 billion Emerging Markets Stock Index Fund (VEIEX) and a related exchange-traded fund (VWO).
“It is looking to take blood in the battle for [emerging market] ETF flows,” the asset-management consultancy Z-Ben Advisors wrote in a note Wednesday about Vanguard. “Its primary, and perhaps only, competitor, BlackRock — via the iShares MSCI Emerging Markets ETF (EEM) — will have to determine what, if any, action will be needed in response.”
While classified as an emerging market, China is the world's second-largest economy and has the world's second-largest stock market. The Shanghai Stock Exchange Composite Index is up 141% over the last year, raising fears of a bubble. Many of the securities in that index are off-limits to U.S. investors.
Vanguard's decision, which will add 1,411 stocks to its fund, comes ahead of a decision expected next Tuesday by the index provider MSCI Inc. over whether it will include Chinese A shares in its broad indexes. That firm backs $48 billion in emerging-markets stock funds and ETFs, including those by BlackRock Inc.'s iShares, according to an InvestmentNews analysis of Morningstar Inc. data.
Outsiders' access to China's domestic markets is controlled, though the country's regulators have welcomed increased foreign investment.
But other asset managers will struggle to match Vanguard's ability to access onshore markets without being granted a share of the action by Chinese securities regulators.
A Vanguard affiliate in Australia secured access in March through a license granted selectively to institutional investors that allows it to access $1.6 billion in securities. BlackRock, by comparison, has access to $1.52 billion, according to Z-Ben.
Vanguard also said it was switching to new indexes on that fund and three other foreign-stock funds that manage $78 billion. The changes will add about 10% exposure to small caps. They also plan to add Canadian stocks to their developed markets fund.
All of the indexes were and are still built by FTSE Group. Vanguard said it did not expect to change the management expenses on the funds.
“We have the experience and the size to be able to provide this to investors. Not all fund managers will be able to do that and some may not want to at this time, but we believe it's the right thing to do,” said Joseph Brennan, the firm's global head of equity indexing.
He said the firm is not worried about concerns the market is overheated or dominated by unsophisticated retail investors.
“The market dynamics will change over time and that's not a concern at all,” Mr. Brennan said.
He said he was hopeful Vanguard would be able to increase its quota to match the size of its fund, the largest tracking emerging markets. Vanguard has said the change will be managed over a period of several months to limit costs to investors, including taxable transactions.