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Talking ETFs With Fund Giant Vanguard

Bert Dalby, a principal in Vanguard's financial adviser group, discusses his firm's VIPERs.


, widely considered the King Kong of index funds, doubled its exchange-traded fund assets in 2005. That's good news for the company, especially because it has been working hard to improve its standing among ETF players.

But despite the big jump in business, Vanguard's trademarked brand of ETFs, VIPERs, still ranks a distant fourth in the overall ETF marketplace, and industry watchers are wondering why it's taking so long for the biggest gorilla in the fund jungle to climb in the rankings.

Through November, Vanguard had a total of $10.6 billion in its VIPERs nest, up from $5.5 billion a year earlier. Within Vanguard, though, the jump was barely a blip, because VIPERs comprise barely 1% of the company's $920 billion in total assets.

Barclay's Global Investors

, by comparison, leads the industry with $164 billion in ETF assets, or 11% of its $1.4 trillion in total assets. Barclays is followed by

State Street


Bank of New York

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, which claim ETF assets of $80.3 billion and $30 billion, respectively.

In order to get a recap of Vanguard's ETF performance in 2005, as well as its game plan for getting ahead in 2006,

chatted with Bert Dalby, a principal in Vanguard's Financial Advisor Services group. How would you characterize the ETF market in 2005?


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: We continued to see growth in ETF assets and an expansion of product offerings in 2005. In addition, price competition entered the ETF marketplace for the first time. The expense ratios of 20 Vanguard VIPERs declined 3 to 12 basis points in early 2005, with the expenses of

Total Stock Market VIPERs

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falling to an industry low 0.07%.

What can we expect from Vanguard in 2006? Any new ETFs on the horizon?

I think you'll see broader acceptance of VIPERs from the adviser community, as well as continued placement on additional brokerage platforms. In the long run, we believe that financial advisers and institutional investors are too savvy not to recognize the advantages of VIPERs -- lower-cost, more broadly diversified ETFs from a recognized indexing leader.

We introduced three international VIPERs in 2005 and we'll continue to broaden the VIPER product lineup in 2006 with low-priced ETFs in several markets, including a dividend-oriented stock-fund offering.

The ETF space is getting crowded with lots of new funds, not all of them gaining traction, including some VIPERs. Is it just too crowded now? Are all these ETFs necessary?

The ETF marketplace is extremely competitive, and investor demand will ultimately decide which ETFs are viable offerings. VIPERs are gaining traction, particularly Total Stock Market VIPERs and

Mid-Cap VIPERs

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. Most of our VIPERs were launched within the past two years and we've done far less in terms of marketing than our competitors. So, we're confident that once VIPERs possess a track record and become more visible among members of the investing community, we'll see additional growth.

We take a long-term view of our potential growth in the ETF market, too. It took nearly 20 years for the mutual fund industry's first index fund --

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Vanguard 500 Index Fund -- to gain acceptance. Today, it is one of the largest mutual funds in the world, with more than $108 billion in assets, which is about a third of the size of the entire ETF industry.

Vanguard is the leader in indices, but when it comes to ETFs you are trailing BGI and State Street. What happened?

We view the ETF market as embryonic at this stage, and Vanguard is the only mutual fund company that offers a broad range of exchange-traded shares of its funds. So, from that vantage point, we believe we're ahead of the game. In November, VIPERs enjoyed their highest monthly cash flow and we've seen VIPER assets double to more than $10.5 billion this year. And our market share of monthly net cash inflows has been growing steadily, which indicates VIPERs are gaining momentum.

ETFs are gaining a bigger percentage of the fund market than ever before. Is this cutting into Vanguard's traditional mutual fund business?

Frankly, we believe that ETFs are growing at the expense of individual stocks, sector funds, and closed-end funds. Vanguard's net cash inflow remains very strong, and with more than $50 billion in net inflows in 2005, we are on pace for one of our best years in our 30-year history. Importantly, our cash flow remains diversified among our product lineup, which includes actively managed and index stock and bonds funds, balanced funds, and money-market funds. Inflows into traditional index funds in 2005, in particular, were robust. In fact, three Vanguard index funds --

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Total Stock Market,

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Vanguard Institutional Index and

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Vanguard Total Bond -- are among the top 20 sellers in the entire fund industry. And Vanguard is the only investment management firm to rank among the top five in traditional mutual fund and exchange-traded fund cash flows.

It is also important to recognize that ETFs are expanding Vanguard's reach in the financial adviser market and to other market participants, such as hedge funds and other institutional investors, which typically shunned traditional index funds.

Which is better for investors: ETFs or traditional index funds? Which would you recommend?

As the only firm to offer both traditional index funds and ETFs, Vanguard is in the unique position to help guide investors to the right choice for them. The difference between a traditional index mutual fund and an ETF is how you invest in it -- directly from the mutual fund provider or through a broker. So, it's really not a question about which index product is better, but which is better for a particular investor.

For a proper evaluation, we recommend that investors consider both quantitative factors and qualitative factors. Quantitative factors include expense ratios, brokerage commissions and spreads. On the qualitative side, an investor should think about the level of importance that you assign to trading flexibility versus investing for the long term. Conventional index mutual funds are purchased and typically redeemed only at net asset value at the end of the day; ETFs can be bought and sold throughout the day at current market price. ETFs can also be sold short and bought on margin. Of course, you pay a price for such flexibility in the form of brokerage commissions and other transaction costs, which should never be left out of the equation.

Vanguard's VIPERS track a lot of MSCI indices which are not as recognizable as the Dow Jones and S&P indices tracked by some of the other ETFs. Does this affect Vanguard's ability to increase assets?

MSCI is a leading benchmark provider and well-recognized in the investing community. In fact, a number of this year's top-selling ETFs track MSCI benchmarks. Vanguard believes that the MSCI indices more accurately represent the target markets tracked by our index funds and include segmentation, style and construction methods that incorporate our view of "best practices." In addition, the MSCI sector indices tend to be more broadly diversified. For example,

Vanguard Energy VIPERs

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, which tracks the MSCI US IMI Energy Index, holds 139 names. Competitor ETFs focused on energy stocks hold less than half that number.