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October 06, 2005
Changing of the Guard: Vanguard Pulls a Switcheroo on SRI Index Providers
    by William Baue

Vanguard is swapping the benchmark for its socially responsible investing index fund from the Calvert Social Index to the FTSE4Good US Select Index.

Five years ago, the Vanguard Group helped usher socially responsible investing (SRI) into the mainstream by licensing the Calvert Social Index (CALVIN) as the platform for its Vanguard Calvert Social Index Fund (ticker: VCSIX). Now, Vanguard is spanning the sea by shifting from a US-based SRI index provider to UK-based FTSE4Good, which customized the FTSE4Good US Select Index to serve as the new benchmark for the renamed Vanguard FTSE Social Index Fund.

Vanguard is holding its cards close to its chest as to the reasons behind the move. Company spokesperson Michael Smith clarified that Vanguard does not consider one index "better" than the other from a social screening perspective.

"Like the Calvert Social Index, the FTSE4Good US Select Index is a well-recognized and -constructed benchmark with clearly-defined social screens that meet Vanguard's best practice standards for index construction--both are free-float adjusted, market cap weighted, screen for liquidity," Mr. Smith told "Vanguard continually evaluates benchmarks from various index providers for possible use by our funds."

FTSE4Good screening criteria overlap significantly with the criteria of the Calvert Group--for example, both exclude producers of tobacco, nuclear power, and weapons. One factor distinguishing the two approaches is that FTSE4Good takes an incremental approach by first establishing "challenging but achievable" standards and then periodically cranking the ratchet with tougher criteria, for example on human rights.

More than such distinctions, however, cost seems to have played a key role in the decision.

"Costs are always important, and Vanguard negotiated on behalf of shareholders a favorable arrangement that will enable the fund to remain among the lowest-cost diversified social investment options available," Mr. Smith said.

However, it is unclear how shareholders will tangibly benefit, as most everything besides the benchmark itself will remain the same.

"The objective, strategy, risks, and management will not change," Mr. Smith said. "The benchmark change is not expected to result in a change to the fund's expense ratio, which is 0.25, and any capital gains realized from the transition are also expected to be small."

The low expense ratio, which Vanguard affords due to its economies of scale, has been a major draw for Vanguard's passively managed SRI index fund, attracting $388 million in assets. In comparison, the Calvert Social Index Fund (CSXAX), Calvert's own index fund based on the CALVIN, has only $55.3 million in assets.

One reason for this difference is unquestionably the broader marketing muscle of Vanguard, but another reason is likely the higher expense ratio for the Calvert-managed index fund. Calvert caps the expense ratio at 0.75, while its actual total annual operating expenses run 1.62 percent (0.45 percent for management fees, 0.25 percent for distribution fees, and 0.92 percent for other expenses). These fees in part support Calvert's social research, as well as its shareowner engagement with companies through dialogue and filing of shareowner resolutions. (The Calvert Social Index Fund also supports community investment as one of Calvert's High Social Impact funds, though the prospectus limits this allocation to one percent and only allows it to proceed after assets surpass $50 million to minimize index tracking error.)

While Vanguard Calvert Social Index Fund investors may have gotten indirect exposure to Calvert's shareowner action (Vanguard paid Calvert licensing fees for the use of CALVIN as a benchmark), they get no such exposure with the Vanguard FTSE Social Index Fund. FTSE4Good is exclusively an index provider and as such does not engage in shareowner action, whereas Calvert's index management takes a back seat to it primary function as a SRI mutual fund firm that engages extensively in shareowner action.

Stepping back to assess the significance of the move for SRI more generally, it continues a trend bridging the gap between the US and Europe, and indeed toward the globalization of SRI. For example, Tokyo-based Sunrise Advisors is now marketing the KLD Global Climate 100 Index (GC100) in Japan, and Europe-based Dow Jones Sustainability Indexes (DJSI) recently launched SRI indexes covering the US and North American markets. And the FTSE4Good US Index is now making its mark in the US.

"There are 27 licensed products globally tied to F4G (including closed-end funds)--Vanguard's is the first in the US," said Lynne Sims, senior vice president for marketing and communications for FTSE Americas. "This is a very positive development for FTSE's growing footprint in various aspects of the US indexing industry."

"It will help to continue to raise the visibility of FTSE4Good and the need for socially responsible investment options for the marketplace," she added.


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