International Small-Caps and Vanguard funds

Vanguard manages two funds addressing the International Small-Caps market segment. The Vanguard International Explorer Fund (VINEX) is one of them. It was launched in Nov-96 by a UK investment company (Schroders PLC), then acquired by Vanguard in Mar-02, and it keeps operating as an active fund to this day.

More recently (Apr-09), Vanguard launched the Vanguard FTSE All-World ex-US Small-Cap Index Fund (VFSVX – also known as VSS in ETF form), a passive index fund.

This articles explores the differences between the two funds, as an attempt to help investors decide which one is best suited for them.

What are those funds tracking?

One of the key differences between those two funds is the respective index that they track, and the definition of those indices:

  • VINEX (actively) tracks the S&P EPAC Small index, which is centered on developed countries in Europe and Asia-Pacific.
  • VFSVX (passively) tracks the FTSE Global Small-Cap ex US Index, an all-world index which includes Canada, plus numerous emerging countries.

In other words, the investor has to decide if exposure should be restricted to developed countries (VINEX), or also include emerging countries (VFSVX). As we’ll see in the following study, this appears to be the primary decision factor, probably more important than the active vs. passive distinction or any past performance consideration.

Note that, somewhat strangely, Vanguard reports that VINEX has in fact *some* exposure to emerging markets (at the end of June 2017, 6.7% of its portfolio). While VFSVX was reported as having 19.1% of its portfolio made of emerging countries, which is consistent with the market weight of emerging markets as part of the overall (ex US) International market — see the breakdown of Vanguard Total International Stock Index Fund (VGTSX).

Active vs. Passive for International Small-Caps

There is significant debate about the fact that International Small might be the last bastion where a talented fund manager can make a true and sustained difference actively managing its fund.

Vanguard’s International Explorer Fund is one of the approximately 20% of international small-cap funds that has outperformed its benchmark over the last 15 years (table below). This category does appear to be one where it’s been a bit easier to consistently beat the index, at least for this particular time period.

ImageSource: 2016 SPIVA Scorecard (S&P)

Past performance: pre-2003 vs. 2003+

The VINEX fund has a fairly long history, and its aggregate performance is pretty good (9.6% from 1997 until mid-2017).  For reference, VTSMX (Vanguard Total Stock Market Index Fund) returned 7.9% during the same time period, while VGTSX (Vanguard Total International Stock Index Fund) only returned 4.8%.

VINEX’s performance before 2003 may not be entirely relevant though, as it wasn’t operated by Vanguard by then. One can suspect that the pre-acquisition VINEX managers may have used a methodology which had relatively little in common with the post-acquisition methodology.

Coincidentally, the FTSE index tracked by VFSVX was launched at the end in 2002. This all speaks to focus the performance comparison to the time period starting in 2003.

Performance analysis (funds): 2003+

The following section analyzes annual total returns (dividends included) from 2003 to 2017. For the years 2003 to 2016, the full year is taken in account. For the year 2017, due to the time of writing of this article, only the first half of the year (i.e. January to June) is accounted for.

As usual with Vanguard funds, the performance is expressed after subtracting the Expense Ratio (ER) of the corresponding funds (at the time of writing: 0.41% for VINEX, 0.27% for VFSVX). Note that VFSVX has no Admiral equivalent, but the ETF form of VFSVX has an ER of 0.13%. Still, we’ll stick to mutual funds for the rest of the analysis.

Since the inception date of VFSVX is Apr-09, the VFSVX historical returns are equated to the historical returns of its FTSE index for the years 2003 to 2009. Since VFSVX is a passive fund, it tracks its index very closely, and such approximation is very reasonable (Vanguard being really good at such index tracking, as demonstrated in the next section).

Let’s look at various metrics now (the following table and most charts in this article were created with a customized version of the Simba backtesting spreadsheet).

VINEX VFSVX Mid-2017 MetricsAs you can see, the historical performance of the two International Small-Caps funds during the past 15 years has been quite similar, with a nominal CAGR close to 11%, outpacing the broader funds being compared in the table. Standard deviation (volatility) and drawdowns were quite high though, and a tad higher for VFSVX, which shouldn’t be surprising given the inclusion of emerging markets.

The following chart is a growth chart of $1 for the same time period, from which similar conclusions can be derived. It all started with a stellar year in 2003 (returns higher than 50% in both cases) for International Small-Caps funds… Note that the vertical axis of this chart uses a log scale.

VINEX VFSVX Mid-2017 Growth

Performance analysis (funds and indices): 2003+

Another thing we can do is to tease out the ‘active’ factor and do a direct comparison with and between the indices that VINEX and VFSVX follow. Getting relevant data turned out to be a bit tricky though. Here are the gory details:

  • VINEX (actively) tracks S&P EPAC Small NR USD (Morningstar F00000T3E2).
  • VFSVX (passively) tracks FTSE Global Small Cap Ex US (US RIC) NR USD (Morningstar F00000VPSV).
  • Vanguard actually provides more history for those two indices than Morningstar, but this remains quite limited for FTSE (which starts in 2010).
  • The corresponding TR series have a longer history on Morningstar, and both of them are available starting from 2003.
  • TR series (total return) are typically higher than the corresponding NR series (net return), due to the tax adjustment factored in NR series (e.g. for non-residents). Check here for more information on those index abbreviations.
  • This requires to neglect the ‘US RIC’ subtlety (check here what that means), but this seems good enough for our goals – actually possibly more consistent.
  • So… to be precise, the comparison was performed between ‘S&P EPAC Small TR USD’ (Morningstar FOUSA0638H) and ‘FTSE Global SmallCap Ex US TR USD’ (Morningstar F00000JNXW). And VINEX and VFSVX.
  • No ER adjustment was introduced on the index series. And VFSVX was equated to its (TR) index for the years before its inception to make a clean chart.

Here is a telltale chart, starting from 2003, using the FTSE TR index as a reference. As a reminder, a telltale chart represents the cumulative growth of $1 for a given investment (say VINEX or VFSVX) divided by the cumulative growth of a reference (here the FTSE index). This type of chart is much more effective than a growth chart to get a good grasp of what happens over time, year over year. See this Wiki page for more details about telltale charts.

VINEX VFSVX Mid-2017 Telltale1The outcome is quite interesting:

  • VINEX and its index have a clearly distinct trajectory from VFSVX (and its index). Which makes sense given that said indices track a different set of countries.
  • VFSVX and its index were very strongly coupled, while VINEX and its index were a bit more loosely coupled (but still more coupled than one might expect for such an active fund). VINEX may be actively managed, but it still tracks its index quite closely.
  • Now remember, we used TR indices, with no ER adjustment. Which means that in both cases, the Vanguard managers actually did significantly better than the NR indices they are supposed to track.

Performance analysis (funds and indices): 1997+

As previously explained, VINEX trajectory before 2003 may not be entirely relevant, but one might still be curious… In addition, it would be interesting to extend the comparison between indices tracking small-caps in developed-only and all-world markets. The S&P EPAC index tracked by VINEX actually goes back to 1990 in its TR form, and should provide a good indication about developed-only countries. The FTSE index tracked by VFSVX doesn’t have such long history, but the MSCI ACWI Ex USA Small is fairly equivalent in its definition (an all-world index mixing developed countries and emerging countries) and goes back to 1995. The primary difference between the FTSE index and the MSCI index is the way South Korea is classified, and that’s a fairly recent event.

Let’s use the MSCI index as a reference this time, and assemble a telltale chart comparing VINEX and the S&P EPAC index to the reference, from VINEX’s inception till now. For the sake of verifying our assumptions, the FTSE trajectory was included, starting from its inception (end of 2002) and equated to the MSCI index for previous years.

VINEX VFSVX Mid-2017 Telltale2This confirms our various assumptions:

  • Most strikingly, VINEX active management before 2003 totally diverged from the S&P EPAC index and did impressively good by then. Those days are over though.
  • The S&P index (developed-only) displayed a trajectory of its own compared to the MSCI (all-world) reference. It turned out a tad better for now, but this all goes in ebbs and flows.
  • The FTSE index is very well aligned with the MSCI index. Only recently is a slight divergence happening, probably mostly due to South Korea.

Tax Considerations

According to this Wiki page about VINEX on the Bogleheads site, its distribution of realized gains is considerably higher than distributions from international index funds, and the dividend yield is also relatively high. Consequently, the fund is usually recommended for placement in tax-advantaged accounts.

According to this Wiki page about VFSVX on the Bogleheads site, this fund is a suitable candidate for placement in taxable accounts.


The bottomline is that an investor has to decide whether they prefer an International Small/Developed fund or an International Small/All-World fund (including emerging markets), and then choose VINEX or VFSVX accordingly. This is by far the #1 criterion for such decision.

On the other hand, the investor probably should not agonize much about corresponding track records, nor the fact that VINEX is (somewhat) more active than VFSVX and has a slightly higher expense ratio. Both funds did well in the past compared to their benchmarks, easily compensating for their fees and then more.

Finally, VINEX might be more suitable for tax-advantaged accounts, while VFSVX would be fine in taxable accounts.

Posted in international stocks, Market history, Vanguard
July 2017
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