Vanguard Total International Stock Index Fund (VTGSX) To Invest Directly In Foreign Securities

In an interesting move, Vanguard annouced yesterday on their website that their Vanguard Total International Stock Index Fund (VTGSX) has modified its mandate to allow the fund to invest directly in the securities of foreign companies. Until now, the Total International Fund has been exclusively a fund-of-funds, meaning it invested in underlying mutual funds of foreign stocks and not the stocks of foreign companies directly. Importantly, the fund will still track the MSCI Total International Composite Index and will keep its expense ratio of 0.27%.

A Good Move For Shareholders

According to Vanguard’s press release, investing directly in underlying securities will allow the fund’s management team more flexibility in managing fund flows and reduce tracking error (although I don’t think this has ever been a problem in the past). More importantly, holding these securities directly will allow fund shareholders to take advantage of the foreign tax credit, which should increase after-tax returns. These moves can be nothing but good for shareholders.

Recently, I wrote about when to use Vanguard’s new FTSE All-World Ex USA Index Fund versus the older Total International Index Fund. As the Total International Fund transitions to owning foreign securities directly, the FTSE fund’s advantages tend to shrink. Its primary advantages, remember, were its inclusion of Canadian stocks (nice, but not a deal-breaker) and its probable superior future tax-efficiency. This new move helps eliminate the tax-efficiency argument, which leaves the Canadian question. The FTSE fund charges 0.40% of assets against the Total International Fund’s 0.27%, a full 48% more. Obviously the additional diversification added by Canadian companies makes the FTSE a superior fund, but is it 48% better? I don’t think it is.

So why did Vanguard make this seemly redundant move? The funds were already very similar and this only serves to make them moreso. The answer, I believe, is that Vanguard eventually intends to merge the two funds into a single large international index fund and this is merely an intermediary step. Combining these funds will increase economies of scale and help lower expenses for shareholders of both funds. Why they didn’t just merge the funds outright is beyond me, but I can’t think of another likely explanation.