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Friday, February 18, 2000

Vanguard Beware

Reported by Hayley Green

In total, Barclays Global Investors has filed to have 51 exchange traded funds (ETFs) listed on the AMEX but the mutual fund industry is paying special attention to the fund which will track the S&P 500 just like Vanguard's S&P 500 fund.

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Vanguard's S&P 500 index fund was the first of its kind, launched on Aug 31, 1976. Since then it has accumulated $140.4 billion or half of the industry's market share for this type of product, according to Financial Research Corp. The next big player following Vanguard is Fidelity with $30.2 billion in its S&P 500 index product. Barclays currently has $2.9 billion in its S&P 500 index, FRC said.

So, what's the big deal? Barclays' ETF is just another index tracking product, some might say. Others might say that SPDRs, which also track the S&P 500, have been on the AMEX for some time but have not proved to be any competition to Vanguard.

The difference lies in the expense ratios and tax efficiency. Vanguard's fund has an expense ratio of 18 basis points, the same as the SPDR. The difference between the SPDR and Vanguard's fund is that the SPDR is a UIT, which is not as tax efficient as a mutual fund. The proposed Barclays ETF, on the other hand, is slated to have an expense ratio of only eight basis points and have even more tax efficiencies than a mutual fund.

"The Vanguard index, the rebel of 1970s, has become somewhat of a conformist and conservative organization. As companies age they loose their flexibility even though they have been the best to date," said Frank Stanton, editorial analyst with Morningstar.

John Bogle's philosophy in creating Vanguard was to create a firm that has the least expensive products. "ETFs have all the benefits of a fund and will suck the money out of Vanguard if they are successful," one industry insider said. "All they have to do is put the product out there and let demand drive it. If they can do it they can demonstrate to the industry that they are a better product than other funds and convert mutual fund investors to ETF investors."

Active managers seem to agree that Vanguard is in lots of in trouble. "Vanguard has backed themselves in the corner as a mutual fund company. By marketing themselves as having the cheapest product and not creating more actively managed funds they have argued themselves out of a job. I find it to be fascinating that as the market has accelerated money has flowed into funds like gang busters," said Dave Lucca, senior partner at Rhoads, Grunden & Lucca an asset management firm with about $110 million under administration.

Other advisors do not believe that Vanguard will see any asset outflows. Lewis Kokernak, senior equity strategist at Martin Capital, an advisory firm in Austin, Texas said, "Vanguard is not scared of this. Vanguard has always been close to the cheapest without being the cheapest." Kokernak also said that the bid/ask spreads an investor must navigate when using an ETF, as opposed to mutual funds, could be sited as a downside.

A Vanguard spokesperson declined comment on its competition. 

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