A few years ago, I was asked to go to Australia as Vanguard’s Asia Pacific chief investment officer. I’d long appreciated the value of diversification in investing, but during my four years Down Under, I gained a much deeper understanding of how diverse and multifaceted the world truly is.

That perspective made a difference more recently when we proposed adopting all-capitalization strategies for four of our U.S.-domiciled international index funds: Vanguard Emerging Markets Stock Index Fund, Developed Markets Index Fund, European Stock Index Fund, and Pacific Stock Index Fund.

Philosophically, it was an easy decision. Vanguard believes deeply in the value of broad exposure and diversification for investors, and an all-cap strategy is about the broadest, most diversified market exposure possible.

But it wasn’t just a matter of adding small-cap stocks. We’d have to reduce large- and mid-cap holdings to reflect their weightings in the all-cap benchmarks. Also, the Emerging Markets Stock Index Fund would add China A-shares, and the Developed Markets Index Fund would add Canadian equities.

After careful consideration of the effort involved and the potential risks and benefits, the trustees of each of the funds determined that the changes were in the best long-term interests of fund shareholders. The decision was announced in June 2015, and our team has just completed the last of the transitions.

Changing conditions in world markets

Small-cap companies were long excluded from international benchmarks because of concerns about liquidity—whether shares in the companies could be purchased or sold quickly and in sufficient quantities. Bid-ask spreads were too large, and trades could be expensive or difficult to execute. For investors seeking international exposure, large- and mid-cap stocks in Europe and Asia (primarily Japan) were considered good enough.

But markets have evolved. Trading liquidity of small firms is better and costs have come down.

In terms of emerging markets, it’s become hard to ignore the fact that China now has the second-largest capital market in the world.1 For investors seeking beta exposure to emerging markets, mainland Chinese companies are a logical part.  Likewise, it made sense to include Canada, which historically had been left out of some developed markets indexes.

We did a lot of work trying to figure out the optimal strategy of converting the funds to all caps. It would require a significant amount of trading—the Emerging Markets and Developed Markets funds had more than $50 billion each in assets under management in June 2015. We worked with FTSE to develop transition indexes that allowed our portfolio managers to make the changes in a systematic manner and keep tracking error to a minimum. The changes could be made to the European and Pacific funds more quickly and without transition indexes.

The transition meant slicing the conversion into small pieces so the market could absorb the trades a bit at a time. This gradual approach allowed us to closely track the transition benchmark and conduct transactions in ways that minimized the cost, reduced the chances of other market participants front-running our trades, and saved value for our shareholders.

Teamwork across time zones

It was an incredible job in both planning and the execution. Our teams across the globe played key roles. Our investment professionals in Australia and Hong Kong were instrumental in working with exchanges, regulators, and brokers in China and Hong Kong. Other teams added legal, risk management, accounting, and technical expertise. And we leveraged the power of our experienced portfolio managers and traders in the United States, London, and Melbourne to execute this large trade with expertise and skill. All told, approximately 200,000 individual trades were executed, involving the sale or purchase of nearly $30 billion worth of securities.

Most important, the transactions were seamless to investors and aren’t expected to result in changes to the funds’ expense ratios or trigger capital gains distributions.

The Emerging Markets Stock Index Fund is now a unique fund—the first broad-based, market-cap-weighted emerging markets index fund to offer China A-shares and all-capitalization equity exposure.2 That means we’re offering deeper and more diversified exposure to emerging markets than other funds.

China is opening up. It’s likely that other index providers and investment firms will add mainland China exposure in the years to come—if you’re telling investors you’re offering broad beta exposure, it has to be included.

1 Source: Quandl, 2015.
2 Sources: Bloomberg and Morningstar.


  • All investing is subject to risk, including the possible loss of the money you invest.
  • Diversification does not ensure a profit or protect against a loss.
  • Prices of mid- and small-cap stocks often fluctuate more than those of large-company stocks.
  • Investments in stocks issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets and, in particular, in countries where market controls may impede investment.