Vanguard Switches Benchmarks on Seven Index Funds

The key reason for the change, Sauter said, is the more sophisticated methodology MSCI uses to determine which stocks make up its indices. The S&P/BARRA indexes, for instance, only use one measure -- price-to-book ratio -- to determine whether a stock belongs in a value index or a growth index. MSCI uses eight criteria to determine if a stock should go in a value or growth index.

"This is a positive move," said John Spence, editor at Indexfunds.com. "You had some weird things going on at the other indexes. Their methodology was too simplistic and there was too much turnover. Every time a big growth company like Amazon(AMZN Quote) or Intel(INTC Quote) had a big run, high-priced growth stocks got pushed over into the value index fund."

Furthermore, by using price-to-book figures alone, frothy tech stocks such as JDS Uniphase(JDSU Quote) and Nortel(NT Quote) ended up in the value index because of a quirk in their accounting. Because of the strange placement of stocks in value or growth buckets, the index funds turned in odd returns. Usually, index funds notch returns fairly close to their category average. But, as Morningstar notes, the Vanguard Value Index fund lagged behind the average large-cap value fund by 7.4 percentage points in 2001. The Vanguard Growth Index outpaced the average large growth fund by 9.2 percentage points that year, according to Morningstar.

Vanguard said the transition to the new benchmarks would take place between April 20 and Sept. 30. The firm doesn't expect the transition to trigger capital gains, but added it might lead to a temporary increase in transaction costs.

While the switchover is a not-unexpected blow to Standard & Poor's -- Vanguard signaled that a change might be in the offing last summer -- it is a potential boon for MSCI, a unit of Morgan Stanley(MWD Quote) that has specialized in overseas indexes such as the MSCI-EAFE index. This also isn't the first time Vanguard has switched indices: Back in 1993, for instance, the trustees of Vanguard Total Bond Market Index Fund approved a change of its target benchmark from the Salomon Brothers Broad Investment-Grade Bond Index to the Lehman Brothers Aggregate Bond Index.

In the interview, Sauter stressed that this move doesn't augur any possible move for the Vanguard 500 index fund. "In the case of the S&P 500, many investors have specifically chosen that index. It enjoys a certain brand recognition, and we don't want to alter that."

The other reason S&P 500 may remain the index of choice: Former Vanguard chief John Bogle struck a deal with Standard & Poor's some two decades ago that capped the fees Vanguard must pay, making the firm's funds more cost-effective than any other index could ever be.