Expert Series: Next Generation Equity: Vanguard ETFs Using CRSP. Sponsored by:

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1 Expert Series: Next Generation Equity: Vanguard ETFs Using CRSP Sponsored by:

2 Moderators: Matt Hougan President of ETF Analytics, Global Head of Editorial IndexUniverse Dave Nadig Director of Research IndexUniverse

3 Speakers: David Barclay Chief Operating Officer CRSP Joel Dickson Principal The Vanguard Group John Heaton Joseph L. Gidwitz Professor of Finance University of Chicago Booth School of Business Lubos Pastor Charles P. McQuaid Professor of Finance University of Chicago Booth School of Business

4 DM #40730 Index Universe Webinar Next Generation Equity Vanguard ETFs Using CRSP December 2012

5 Highlights of New CRSP Indexes Objective and transparent rule-based methodology Quarterly reconstitution Slow migration Partial weighting Size breakpoints based on cumulative market cap Multifactor approach to Value and Growth 2

6 About Chicago Booth Founded in1898, second oldest business school in the U.S. Six Nobel Prize laureates on faculty Consistently ranked among top five business schools Programs offered on three continents: Asia, Europe & North America A global body of nearly 47,000 accomplished alumni 3

7 Who is CRSP? Established in 1960 One of 11 Chicago Booth research centers Provider of premier historical U.S. stock market databases CRSP data spans 87 years 500 clients in 32 countries Total returns delivered daily from 2003 to 2009 to NASDAQ 72 staff members 34 dedicated to indexing 4

8 CRSP Board of Directors Eugene F. Fama Robert R. McCormick Distinguished Service Professor of Finance John Heaton Joseph L. Gidwitz Professor of Finance Deputy Dean for Faculty John H. Cochrane AQR Capital Management Professor of Finance Steven Neil Kaplan Neubauer Family Professor of Entrepreneurship and Finance Douglas W. Diamond Merton H. Miller Distinguished Service Professor of Finance and Richard N. Rosett Faculty Fellow Toby Moskowitz Fama Family Professor of Finance 5

9 How Does CRSP Define Size? CRSP Mega-cap: 0% - 70% CRSP Mid-cap: 70% - 85% CRSP Small-cap: 85% - 98% CRSP Micro-cap: 98% - 100% CRSP Large-cap: 0% - 85% 6

10 Changing Number of Stocks over Time (all securities listed on NYSE/AMEX/NASDAQ)

11 Size Indexes # securities market cap CRSP Total Mkt 3800 $15.6 CRSP Mega-cap: CRSP Mid-cap: CRSP Small-cap: CRSP Micro-cap: CRSP Large-cap: September 7, 2012 ranking ($ in trillions) 8

12 How Does CRSP Maintain Indexes? Quarterly Rebalance Threshold Security must exceed cap band before migration begins Packeting Once migration begins, 50% of a security s cap is moved; remaining 50% is moved if the security remains beyond the band in subsequent periods 9

13 Migration Example Initial state (point A): Company is at 79% - 100% in mid cap Q2 state (point B): Company is ranked at 69% - 100% in mid cap Q3 state (point C): Company is ranked at 63% - 50% mid/50% mega Q4 state (point C): Company is still ranked at 63% - 100% in mega 10

14 How Does CRSP Define Style? 11 factor model determines stock s value and growth 5 value factors 6 growth factors Factors selected based on economic and empirical work Many existing factors used by industry and studied in academia Recent factors derived from empirical work 2600 weighting schemes were considered Value and growth appraised individually Composite scoring reflects reality (securities may be high growth, high value, neither, both) 11

15 Style Factors Value: Book-to-Price Forward Earnings-to-Price Historical Earnings-to-Price Dividend-to-Price Sales-to-Price Growth: Future Long-term Growth in EPS Future Short-term Growth in EPS 3-year Historical Growth in EPS 3-year Historical Growth in Sales per Share Current Investment-to-Assets Ratio Return on Assets 12

16 Factor Weights G = Growth score = (2/3)*FG + (1/3)*HG, where FG = Forward growth score = (1/3)*zFLGE + (1/3)*zFSGE + (1/6)*zINV + (1/6)*zROA HG = Historical growth score = (2/3)*zHGS + (1/3)*zHGE V = Value score = (2/3)*V1 + (1/3)*V2, where V1 = (2/3)*zEP + (1/3)*zBP, where zep = (2/3)*zFEP + (1/3)*zHEP V2 = (2/3)*zSP + (1/3)*zDP 13

17 Combining Value and Growth Indicators 1 AR = 0.5 Value Stock AR = 0.8 Growth Rank RV Growth Stock AR = 0.2 RG Band Region 0 Value Rank 1 14

18 Results of CRSP s Style Methodology Value Metrics Small Value Small Growth 35.0x 30.0x 25.0x 20.0x 15.0x 10.0x 5.0x 0.0x 33.0x 1.6% 23.1x 13.4x 15.4x 0.5% 2.5x 1.2x 1.8x 0.6x Forward P/E Historical P/E P/B P/S D/P 1.8% 1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% 15

19 Results of CRSP s Style Methodology Growth Metrics 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 10.0% 17.9% Analyst Long Term Earnings Growth 11.4% 35.2% Analyst Short Term Earnings Growth Small Value 15.5% 28.0% 3Y Average Growth in Earnings Small Growth 6.0% 18.2% 3Y Average Growth in Sales 7.4% 5.6% 3.5% 3.1% Investment Rate ROA 16

20 Small Value & Small Growth Sector Weights Oil & Gas, 3.78% Health Care, Basic 5.31% Materials, 6.20% Small Value Telecom, 0.78% Financials, 26.57% Health Care, 15.54% Oil & Gas, 6.65% Small Growth Telecom, 1.21% Financials, 14.66% Technology, 6.66% Industrials, 16.76% Utilities, 7.61% Basic Materials, 4.00% Consumer Goods, 8.76% Consumer Services, 12.15% Industrials, 22.17% Technology, 16.86% Utilities, Consumer 0.47% Goods, 8.72% Consumer Services, 15.13% *As of September 28,

21 Summary CRSP s expertise spans more than 50 years CRSP has over 500 clients in 32 countries CRSP Indexes align with our mission Size breakpoints are based on cumulative market cap Unique multifactor model is used for value and growth Packeting migrates securities gradually and maintains style purity while minimizing turnover Thank you! 18

22 DM #40730 Index Universe Webinar Next Generation Equity Vanguard ETFs Using CRSP December 2012

23 Indexes rebalance normally with natural turnover VVIF Mid-Cap Index Portfolio Institutional Total Stock Market Index Fund Small-Cap Value Index Fund Small-Cap Growth Index Fund Small-Cap Index Fund Mid-Cap Value Index Fund Mid-Cap Growth Index Fund Mid-Cap Index Fund Mega Cap Value Index Fund* Mega Cap Growth Index Fund* Mega Cap Index Fund* Value Index Fund Growth Index Fund Large-Cap Index Fund Total Stock Market Index Fund Source: Vanguard calculations, as of December 31, * Mega Cap Value Index Fund, Mega Cap Growth Index Fund, and Mega Cap Index Fund, as of August 31, % 5% 10% 15% 20% 25% 30% 35% 40% 45% Annual turnover rate FOR FINANCIAL ADVISORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 1

24 Benchmark comparisons Comparison of current index and new index for Vanguard Total Stock Market Index Fund/ETF Current index CRSP US Total Market Index Difference Weighted median market cap $34, $34, $ Number of securities 3,241 3, Trailing P/E Sources: MSCI and CRSP, as of October 31, The financial characteristics shown above are the result of each index provider s individual indexing methodology, and can be expected to vary over time. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index FOR FINANCIAL ADVISORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 2

25 Sector weights Benchmark comparisons Comparison of current index and new index for Vanguard Total Stock Market Index Fund/ETF 20% -0.26% 18% 0.07% 16% 14% 12% -0.13% 0.12% 0.04% 0.01% 0.07% 10% 8% 6% 4% -0.03% -0.01% 0.11% 2% 0% Consumer discretionary Consumer staples Energy Financials Health care Industrials Information technology Materials Telecom services Utilities Current index CRSP US Total Market Index Sources: MSCI and CRSP, as of October 31, The financial characteristics shown above are the result of each index provider s individual indexing methodology, and can be expected to vary over time. FOR FINANCIAL ADVISORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 3

26 Benchmark comparisons Comparison of current index and new index for Vanguard Mid-Cap Index Fund/ETF Current index CRSP US Mid Cap Index Difference Weighted median market cap $6, $7, $1, Number of securities (88) Trailing P/E Sources: MSCI and CRSP, as of October 31, The financial characteristics shown above are the result of each index provider s individual indexing methodology, and can be expected to vary over time. FOR FINANCIAL ADVISORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 4

27 Sector weights Benchmark comparisons Comparison of current index and new index for Vanguard Mid-Cap Index Fund/ETF 20% 18% -0.82% -2.33% 16% 14% 12% 1.21% 0.30% 0.06% 10% 8% 2.35% -1.16% -0.99% 0.80% 6% 4% 2% 0.57% 0% Consumer discretionary Consumer staples Energy Financials Health care Industrials Information technology Materials Telecom services Utilities Current index CRSP US Mid Cap Index Sources: MSCI and CRSP, as of October 31, The financial characteristics shown above are the result of each index provider s individual indexing methodology, and can be expected to vary over time. FOR FINANCIAL ADVISORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 5

28 Benchmark comparisons Comparison of current index and new index for Vanguard Small-Cap Growth Index Fund/ETF Current index CRSP US Small Cap Growth Index Difference Weighted median market cap $1, $2, $ Number of securities (339) Trailing P/E Sources: MSCI and CRSP, as of October 31, The financial characteristics shown above are the result of each index provider s individual indexing methodology, and can be expected to vary over time. FOR FINANCIAL ADVISORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 6

29 Sector weights Benchmark comparisons Comparison of current index and new index for Vanguard Small-Cap Growth Index Fund/ETF 25% -1.74% 20% 2.61% -3.19% -4.53% 15% 8.43% 10% -0.07% -1.40% 5% -0.90% 0.38% 0.43% 0% Consumer discretionary Consumer staples Energy Financials Health care Industrials Information technology Materials Telecom services Utilities Current index CRSP US Small Cap Growth Index Sources: MSCI and CRSP, as of October 31, The financial characteristics shown above are the result of each index provider s individual indexing methodology, and can be expected to vary over time. FOR FINANCIAL ADVISORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 7

30 Important information For more information about Vanguard funds, visit advisors.vanguard.com, or call , to obtain a prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing. Vanguard ETF Shares are not redeemable with the issuing Fund other than in Creation Unit aggregations. Instead, investors must buy or sell Vanguard ETF Shares in the secondary market with the assistance of a stockbroker. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling. All investing is subject to risk, including possible loss of principal. Prices of mid- and small-cap stocks often fluctuate more than those of large-company stocks. Connect with Vanguard >advisors.vanguard.com Vanguard Marketing Corporation, Distributor of the Vanguard Funds The Vanguard Group, Inc. All rights reserved. U.S. Pat. No. 6,879,964 B2; 7,337,138; 7,720,749; 7,925,573; 8,090,646. 2Q2012PID LA Investment Products: Not FDIC Insured No Bank Guarantee May Lose Value FOR FINANCIAL ADVISORS ONLY. NOT FOR PUBLIC DISTRIBUTION. 8

31 Thank You. Questions?