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Bogleheads on Investing with Christine Franquin and Michael Perre: Episode 51

Post on: October 27, 2022 by Rick Ferri

For our 51st Episode of Bogleheads on Investing Podcast, host Rick Ferri interviews  Christine Franquin, a principal and senior portfolio manager in the Vanguard Equity Index Group, and Michael Perre, also a principal in the Vanguard Equity Index Group.

Christine manages several equity and balanced funds, including funds for U.S. and international investors as well as indexed separate accounts, and Michael oversees the portfolio management of Vanguard’s internally managed equity index funds. He is involved with the daily trading and portfolio management of those funds.

International stock investing has not delivered close to the returns of the US market for nearly fifteen years. Should investors ignore international stocks as Jack Bogle suggested, or embrace them for broader diversification?

In this podcast, we discuss these questions and more.


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Rick Ferri: Welcome to  Bogleheads on Investing, episode number 51. This episode is all about international stock investing.  Today we have two special guests, Christine Franquin and Michael Perre.  Both are principals and portfolio managers in the Vanguard Equity Group that oversees trading and management of the international equity index funds here in the U.S.

Hi everyone. My name is Rick Ferri, and I'm the host of Bogleheads on Investing. This episode, as with all episodes, is brought to you by the John C Bogle Center for Financial Literacy, a 501(c)(3) nonprofit organization dedicated to helping people make better financial decisions.  Visit our newly designed website at Bogelcenter.net to find valuable information and to make a tax deductible contribution.

Today our discussion is all about international investing and specifically investing in international stock index funds. We have two special guests, Christine Franquin, a principal and senior portfolio manager in the Vanguard Equity index group and Michael Perre, also a principal and portfolio manager in the Vanguard Equity index group.  Christine's background is from trading.  She was the first person hired by Vanguard to trade in the European markets in Europe.  Michael Perre has been with Vanguard for his entire career and has moved his way up to a senior position where he assists not only in the portfolio management of the index funds but in the construction of the indexes themselves.

So with no further ado let me introduce Christine Franquin and Michael Perre. Welcome to the Bogleheads on Investing podcast.

Christine Franquin: Thank you for having us.

Michael Perre: Thank you.

Rick Ferri: Well thank you for being on the show.  We have a lot to discuss today. We all know that the international equity markets have not kept pace with the U.S. markets over perhaps 15 years now. And emerging markets have not really given us any return here in the United States for that period of time with the exception of perhaps dividends. So we're going to talk a lot today about investing in international stocks, and I believe it still is a good idea to do this, and why Bogleheads would want to continue to do this.

Before we get to that point, I do want to get to know you a little bit.  So Christine could you just give me a two-minute synopsis of how you got to the position you're at today?

Christine Franquin: Sure. So as you can hear, I'm not exactly raised in the US. I have a nice French accent. I'm from Belgium. I've been at Vanguard about 20 years, so a little bit more than 20 years, and I was hired by Vanguard to start the first trading desk outside of the US. So when I got hired I started working in the States for a year before they shipped me to Europe to start the first trading desk, and the idea there was really to help Vanguard reduce transaction costs by having somebody on the ground to trade the stocks for the U.S shareholders.

So I did that for 10 years, created the trading desk in Europe, and then about 10 years ago I was asked to come to the US where we developed  a more global presence ,and really represent that global view in the US. And I've been a portfolio manager here for probably 10 - 11 years now.

Rick Ferri:  And you have your undergraduate degree that you received in Belgium and you have an MS in Finance from Clark University, and you have a law degree as well.

Christine Franquin: Yes, I did practice law for three years in Belgium before I came to the US. And the main reason I actually came to the US, at first, was to improve my English, because I couldn't speak English. I speak Dutch and French. And that's when Vanguard found me and they gave me the opportunity to do something. I did nothing I could do, which is stop treating people through your manager, so I took the opportunity, came to Malvern 20 some years ago. I love the team. I stayed ever since, so I'm one of the rare persons in the trading room that actually got hired in the trading room and I'm still in the same team working with the same people, which is really a treat and a pleasure.

Rick Ferri: And Michael could you tell us something about your background and how you ended up in the position that you're in as a portfolio manager.

Michael Perre: Vanguard is my first job out of college. Thirty-two years ago I started in our

fund accounting area where I learned a lot of how the operations work. So trade settlements, pricing, cash movements, everything. And I think the first impression that I had when I started was the culture. Definitely, Jack had the culture of doing the right thing for investors. And low cost, and it kind of struck you when you went into the copier machine-- there was a little metal box at the top and you were expected to put a nickel in the box if you made personal copies. And I don't think anyone monitored it, but it was just a reminder that every penny counted. Yeah definitely was a focus to keep costs low.

Rick Ferri: I remember that, Jack telling that story, and others at Vanguard telling that same story.

Michael Perre: It's true.

About 25 years ago or so I got to the trading desk and I've been working on both domestic U.S.funds, and then eventually moved over to work on our global portfolios. I've been one of the portfolio managers on Total International since we went direct investment. So before, it was set up as a fund of funds and then direct, we've been there from the start.

Rick Ferri: And when was that? I recall that that all took place--when was that--that it went from a fund of funds to a direct investment? In other words, you bought all the stocks in that fund.

Christine Franquin: I would say, 15 years ago, because I was on the receiving end of Mike’s trades.

Michael Perre: We had used a couple different underlying funds, Europe, Pacific and Emerging were the underlying. One of the big things was we're missing Canada from our total world fund. So we had a pretty good amount of Canada to buy in that transition. So it took a bit of planning, and over the years we've had a few transitions like that with multiple funds, where the bottom line is we try and get into the names as cheaply as possible, with the lowest cost possible. So trading is definitely a focus for us, in minimizing trading costs and transaction costs.

Rick Ferri: Vanguard has two total international funds, and we'll get into a little bit of the history of that in a minute. But before we go down that path I want to go to a 30,000 foot level and look at the world equity market. And the world equity market is about 60 percent U.S. stocks and 40 percent international from a capitalization weighted, not GDP, but capitalization weighted. Could you differentiate what makes a U.S. company and what makes an international company? Is it just where the headquarters are located? How is this decided in an index?

Michael Perre: So it depends on the index. They all have their own criteria for---say, FTSE and MSCI--they look at a few things. They look at headquarters, they look at primary listings, and then they look at where the companies are incorporated. So they really take into account several different factors when they're identifying where the country should be.

Rick Ferri: Is it safe to say that if you bought a total U.S. stock market index fund and a total International index fund, that all of the securities are mutually exclusive, that there's no overlap because there are two different index providers?

Michael Perre: So I couldn't say a hundred percent but it's probably somewhere in the 99.9 range. It's pretty standard where companies are classified. There might be small differences between the indexes, but for the most part you're safe. There's not any overlap.

Rick Ferri: So within the foreign market, which is also called the international market, which is also called the ex-US market, meaning excluding US. We've got developed markets and emerging markets. And how does that get differentiated among the index providers?

Michael Perre: So I'll take that one too since I'm on the FTSE policy committee and was on their country classification committee for probably almost 10 years. So FTSE has a criteria, a list of criteria, it's about 21 criteria, some of them are based on economic factors. There's others that are based on market forces, transaction costs, and liquidity. There's a bunch of factors and if the country meets a certain number of factors they get put on a watch list, and the committees will review the countries on the watch list and determine whether those countries have made significant progress in terms of trading. 

And the actual committee will make a recommendation to FTSE in terms of whether it should be developed or emerging. The people on that committee are from a few different spots, so there's the buy side, there's investment companies like us, there's brokers that are in, all over the world that give their opinions. There's custodial banks. So you really have a lot of expertise that come together on a quarterly basis to talk about these countries on the watch lists.

Now for the most part the indexes are pretty much in agreement with the countries. There are a few differences, one of which is Korea. So FTSE has Korea classified as developed. MSCI has it classified as emerging markets. It's kind of an interesting one because economically I don't think there's any argument that Korea is developed from all the metrics, but certainly operationally there's some challenges to trading, and some market frictions that make it trade more like an EM country.

So there could be slight differences like that. Now Korea is a pretty big one, so that's the major one, but there's smaller ones too. But for most countries they're aligned between the indexes.

Rick Ferri: Now let's talk about the two-ton gorilla in the room which is China. China is a big country. They have a big economy but it doesn't seem to be a very large percentage of the international indices, or the emerging market indices. And why not?

Michael Perre: I also manage the Emerging Markets portfolio so this is near and dear to my heart. So China actually has listings not just in mainland China but they have listings in Hong Kong. They have listings in the U.S. They have listings in Singapore. The names that are listed in mainland China are capped at 30 percent foreign ownership. So all the indexes adjust for that foreign investment limitation. And then on top of it, it's not fully included. So for FTSE, they only have it at a 25% inclusion rate and for MSCI it's 20%. The reason is because there are frictions with the operations and the way the market trades that are different than other markets. So I think the index providers want to see some improvements in terms of some of those frictions, and they'll continue to increase the weight down the road.

Rick Ferri: So aside from restrictions on weights with China, perhaps a few other countries, the international indices are for the most part what's available to trade, I assume, is a cap weighted index, a free float capitalization weighted, which means the stocks that are available for anyone to buy. Is that a fair assessment? 

Christine Franquin: That's a fair assessment, especially the free float factor is probably a very key element in the international market. So if you're looking on the US side there's not a lot of companies that have a free float factor that adjusts how much is available for external shareholders. When in Europe if I take where I come from, you have only part of certain critical companies. The same thing in Indian emerging markets. So what's actually available for foreigners, or even regular shareholders, to buy is smaller. So the index adjusts for that. 

So that would be probably a much bigger component of the index composition on the international side. If you compare that to U.S., indices have less of those free float factors playing the role.

Rick Ferri: So I just want to understand this. So it's basically the indices that are used in the U.S. are for what U.S. investors can buy. Not all that's available. In other words, in China they can only have a certain percentage that can be foreign investors. So we can only invest a certain percentage as U.S. investors directly in China's stock market but it could be much bigger than that. I mean the market itself is much bigger, correct?  It's just the indices that we use, and the index funds that we have, limit us to just what is available to U.S. investors, is that correct?

Christine Franquin: It's not to U.S. investors. So if you're looking at the China situation, like the foreign room is how much is available for foreigners to buy, so the index kind of cut it off and that's more an arbitrary cutoff, actually, that was truly available. If you're looking, free float is truly looking at the ownership of any single company and taking out of that weighting like the market capitalization of the company, what's not available for sale.

So you have long-term cross holding. So if you're looking in Japan you have Toyota buys a lot of the suppliers. They own 30 to 40 percent of the suppliers chain that's never going to be available for shareholders of any Japanese or US, so any person in the world to buy. So basically what the index provider does, they reduce the market cap of the company from the full weight to what we call the free float weigh.

Christine Franquin: So basically if you are looking, the purpose of currency hedging is truly to diminish volatility over time. So over the course of the last few months if you are European-based investors or US dollar based investors, because of the way the currency has moved, you either made a lot of money or lost a lot of money, just based on the currency movement.

But over time that volatility kind of eases up so historically the currency of volatility of a period of 15 - 20 years is really not a big element of your investment return. So for equity which is an asset class that's normally by itself overly volatile, it doesn't feel like it's really necessary to start diminishing the volatility of returns by trying to reduce the volatility of currencies.

For the bonds for which there's very little volatility in the investment returns themselves, the volatility of the currency can actually wipe out all your return that you will have. So for that we offer currency hedging. So it's really based on the volatility of the asset class that that decision is being made.

Rick Ferri: So at least the Vanguard investors who are investing in the total International, developed markets, for emerging markets it's an unhedged portfolio, there's no currency hedging.

Christine Franquin: There's no currency hedging.

Rick Ferri: You know the foreign markets, I looked at this year, and kind of doing about as well as the U.S. equity market. But what I noticed was if you take out this currency devaluation of foreign currencies and the appreciation of the dollar, that this year International stocks in their native currencies, if they didn't have--if they were hedged--international stocks would be outperforming by about 10 percent. They'd be outperforming the US even though they'd both be down. It's because not only are the stocks down some internationally, but the strength of the dollar has pulled down foreign stocks to the point where they're about on par with the U.S. market. But I don't think a lot of people realize that International stocks in their own native currencies are actually outperforming the U.S. market.

I believe and correct me if I'm wrong one of the reasons why International stocks would have outperformed US stocks if it wasn't for this currency difference with the strong dollar is because of the structure of the industry groups in the international markets. They tend to be very different and have very different weightings than the U.S. market, which tends to be heavy health care and heavy technology. So in your experience can you tell us how different weightings of industry groups between US and international does affect this difference in return, and has affected the difference in return say over the last 10 years.

Michael Perre: It's basic theory in terms of pricing. So if you have cash flows that are in the future, if you get it in an area where there's rising interest rates and you discount those future cash flows, industries like technology probably don't expect to generate profits until far in the future. So a lot of those companies are going to be more impacted in a period of raising interest rates. Where if you look at foreign companies there's a lot more financials, and a lot of the financials have maybe cash flows that are more short-term in nature. You're more likely to have dividend payments, so that the interest rate rise wouldn't affect those types of companies as much as technology companies. That could be a reason why an index with more financials is doing better, once you strip out currency, than technology indexes.

Christine Franquin: You also have more basic material, more energy, more industrials in the international markets than you have on the US market, so if you're looking at where we are from an energy perspective with the war in Ukraine and everything. So that's a tendency to probably have a prospect of bringing short-term returns that are higher than in the technology sector for the reason that Mike explained.

Rick Ferri: I did a compare on the Vanguard website, and I compared the Vanguard Total International Stock Fund to the Vanguard Total US Stock fund, and when you do that it gives you a lot of information. One set of information is this industry sectors, and the big one it seems to be internationally have a much bigger allocation to materials, financial services, industrials, energy, and a much lower allocation to healthcare and technology.

So when you see these industry groups rotating around this seems to be a good environment, or has been a good environment for the more commodity driven sector and financial driven sector of the market, which would have normally caused international stocks to outperform if not for the fact that the U.S. dollar has been strong.

Now the other thing that's interesting about the compare function on Vanguard and looking at these two funds side by side are the vast differences in valuations between price to earnings ratios, price to book ratios, earnings growth rates. And let me just go over them. The P/E, price to earnings ratio, this is based on September 30th data of the Total U.S. Stock Market Fund is about, was about, 17 times earnings. It was only 10 times earnings in the Vanguard Total International. The price to book in the US market was about three times book. It was half that in the international fund, the Total International, and the earnings growth rate in the US was around 20 percent it was about half that internationally .So I always look at the international market and say if I ever wanted to buy a value index without buying a value index all I have to do is buy International stocks.

Michael Perre: Certainly our investment strategy group is in agreement with your premise. So they definitely see that over the next 10 years there's probably an opportunity for international stocks to have better returns than US stocks primarily for the reasons that you said – P/E ratios are much less, price to book is much less. We just had currency moves, pretty substantial currency moves, in the last few years, with a dollar strengthened.

So I think our investment strategy group is in agreement that there is probably more opportunity for equity-like returns in international equities than U.S. equity.

Rick Ferri: Historically, if you go back 30 years and you look at the P/E ratios and the forward earnings price to forward earnings and so forth, I mean emerging markets in particular are about the lowest they've been and developed markets are getting pretty darn low also. So it really is an interesting--not to make a prediction about what's going to go happen in the future--but just from a valuation standpoint, if there's any kind of a regression to the mean just for emerging market stocks and international stocks just to regress back to say 14 times earnings or something which is sort of the middle of the road of where they normally trade at, 14 to 15, it does seem to me that if you're not in international equities that it might be a good idea to diversify into them, and if you are in international equities, well certainly don't make a decision based on the last 10 years to get out.

I also want to point out one more thing about International equities, for people who need dividends. My gosh, I mean I think the Vanguard Total International Index Fund right now is yielding about four percent, true? Is that correct?

Michael Perre: Yes. So I definitely had looked at that recently and that is true it's four percent.

Rick Ferri: Well that's a phenomenal yield. You know, if you're going to just--if you believe that well even if the economy goes into a recession, or the global economy goes into a recession, there might be some cuts in dividends--but still to get that cash flow for a retiree, and it is not a bad cash flow in their portfolio.

I do want to mention though, something having to do with the dividend, and we'll talk about this at a very high 30,000 foot level, but if you have international stock index funds in your taxable account you don't get the full dividend. Some of the countries actually hold back a portion of the dividend that's paid to you as a US investor. They hold it back in the form of a tax. And the way that we get this money back is through a foreign tax credit that we take on our taxes. Now this is only available to people who have international funds in their taxable portfolio. But can you talk a little bit about the foreign tax credit and how that works.

Christine Franquin: So we at the fund level, we get what you described. So tax in the fund itself---granted we have a great tax team at Vanguard--so there's a lot of treaties with the different countries that allow us to get back some of that taxation. So a tax team is really involved with all the different tax authorities across the globe to get as much back as we can based on those treaties that have been signed by the US government.

So that's the first step of trying to prevent paying taxes, is really having an engaged team that works with the custodians across the globe to get that back. When you're in a taxable account you get a nice report from Vanguard at the end of every year that actually shows you how much of that tax that you pay, that you can credit from your U.S. taxation. So that's how it works.

Rick Ferri: I just want to make one caveat. A lot of people talk about putting the World Equity Fund [Editor’s note: Rick probably means the Vanguard Total World Stock Index Fund - VTWAX] in their taxable portfolio, but there's a little quirk in the IRS tax code, and again I'm not a tax expert either, that says that if unless the fund is more than 50% international then you don't get this tax credit. So you wouldn't want to put the World Equity Fund in your taxable portfolio. You'd want to split it between the U.S. Total Stock Index Fund and the Total International so you could get the tax credit from the international fund.

Christine Franquin: So I wish I could say that you have the same tax advantage in Total World as you have in that are international, but it's different just because Total World has 60% of its assets invested in US securities, so we don't get the tax form credit back through Total World. So you probably from a tax perspective are better off choosing to use Total Stock and for international to get the same exposure.

Rick Ferri: Thank you for validating that. So now I'm going to talk a little bit more about these indices from various providers. The index providers have different ways of doing things. For instance you're following two different FTSE indices for two of your different total International stock index funds. The Vanguard Total International Stock ETF (VXUS)  follows the FTSE Global All Cap ex-US Index which has 7991 constituents, or names in it, or companies in it. But then you also have another total international fund called the FTSE All World ex-US (VEU) and that follows the FTSE All World ex-US Index. So tell me what the difference is please between VXUS and VEU, I mean the word all cap is in VXUS and it's not in the VEU. So please explain this.

Michael Perre: So Global All Cap VXUS is exactly that, it's all caps. So it's large caps, mid caps, and small caps, and it represents close to 100% of the market cap available in the world ex-US. The FTSE All World is just large and mid caps. There are no small caps in the FTSE All World. The way that FTSE separates large, mid, and small is they try and take the top 86 percent of the universe and they make that large and mid. Now there's buffers, so that names don't move between mid cap and small cap, and helps reduce the turnover for investors. But in general, you can assume that FTSE All World is primarily large and mid and does not have small caps in there.

Rick Ferri: Okay, this is interesting because I also looked at your competitor, iShares and they follow the MSCI ACWI ex-US IMI Index that has 4,300 names in it. And then Fidelity has a Total International Fund and they follow the MSCI ACWI ex-US Investable Market Index that has 5045 names in it. Fidelity also has the Fidelity ZERO Fund, but it only has 2458 names. So even though all of these funds are called Total International, really the only true Total International Index Fund out there is the Vanguard Total International stock ETF with the ticker VXUS which has about eight thousand, and the rest of them, all of the rest of them have at least three thousand less. So if you really really want a true Total International Index Fund it seems like you would go with the Vanguard Total International stock fund or ETF.

Micheal Perre: Yeah so the difference is methodology. And the methodology is that FTSE actually has more names in the index because they're cut off to get into the index in terms of size is lower than what MSCI has. So it's lower because what FTSE does is they look at companies by region, rather than MSCI looks at it by developed and emerging, and then cuts across and says this is the minimum market cap that we will accept in our index. So the result is FTSE’s thresholds for index entry are a lot smaller in terms of market cap in a lot of the other global markets. You have companies that are 100 to 200 million dollar market cap in terms of size, where MSCI cuts it off at about roughly 300 million.

Rick Ferri: And it seems that even though the correlations between these funds are 99%, or the r-squared is .99, I'm at the very, very, very close, that in fact that there are these very, very, very minor differences. I looked at the 10-year performance-- you know the Vanguard, the FTSE All-world ex-US and the Vanguard Total International stock ETF over a 10-year period of time ending in September 30th and the Vanguard FTSE All-world ex-US ETF compounded at 3.32 percent and the Vanguard Total International stock fund compounded at 3.34. So I don't know if there's much difference between these two. But if you go into--you know the market's down this year--if you own the Vanguard Total International stock ETF and you want to take a tax loss, you could sell that stock fund and you could buy the FTSE All-World ex-US, it is a different index, it is a different fund, that has a different CUSIP, so in my view it's not substantially identical--but again we're not tax experts here--but the performance is very close, and all of these funds the performance is very close.

Micheal Perre: Yeah I would agree. I think methodology across all of the indexes conformed over the years. So everyone has float-adjusted, everything's based on market cap, very similar.

Rick Ferri: Well I want to get into how you do your jobs now. I mean you're in the U.S, you're trying to come up with an NAV [Net Asset Value] at the end of the day for the open-end fund. The ETF is trading in the U.S. during our normal business hours but all of these markets are closed. So how do you do that? I mean you get money into the fund, you have to put it to work. You tell me, on a day-to-day basis it's much harder to manage these international stock funds when the markets are closed. How do you do that?

Christine Franquin: European markets close around 11 30 a.m, so after 11 30 a.m basically the only thing that's really investable is Canada and Latin, which is a very small portion of that portfolio. So if we get any cash for what, we will go--we will revert to the futures market which is trading all the way to 4 pm New York time--so we will invest what we are receiving in the future market, and then trading this for the following day where we can invest basically in the local market. So we will do a switch from futures to equities as those markets open. We will send trades actually across the globe--which I was one of the first ones they sent trades to--but that's why we had that presence across the globe. We have presence in London. We have presence in Melbourne in Australia. And we actually asked those traders that are really part of our team, they're an extension of us, to look at the future position, look at the equities and to help us transform that future risk into equity risk and make sure that the investment is done smoothly. So they understand the market, they know how to trade, they know how to source liquidity. They really are our partners into the management of the funds as there are trading methodologies in terms of when to include IPOs or secondary offerings. So it doesn't surprise me that the returns have been pretty similar.

Michael Perre: Yeah, just to confirm what Christine said. We rely on the local expertise of our trading desks. We have one in the UK, one in Australia. They've become experts in those markets. So they're trying to save as much costs as we can for the ultimate investor. We're constantly evaluating the tools that we use to access those markets. We're using the ones that perform better. There's an evaluation process. We have a transaction cost team that looks at all of our trades on a regular basis and gives us feedback, not just us, but the other regions, about what tools that we use perform the best. We continue to use the ones that work the best more. So transaction costs are huge and it's like saving that nickel in the copier machine, we're trying to add to save costs around the edges and ultimately it means better returns for our investors.

Rick Ferri: Good. Michael, could you elaborate on transaction costs. How--you know here in the US we've gotten to the point where it seems to be almost a de minimis amount for mostly mid cap and large cap stocks, but that's not true with a lot of emerging markets and even some developed markets. Can you kind of give us an overview of how much it costs to trade in various countries. And which ones are expensive, which ones are not, and how expensive is it for a Vanguard Total International Fund Investor to to hold the fund from a transaction standpoint?

Michael Perre: So in terms of commissions, commission rates we get in the U.S. are very, very low and the spreads in the market are very tight. When you go overseas some markets trade well but others do not. So like if we trade in Latin America and we're trading a mid cap or a small cap name in Mexico or Brazil, the spreads are going to be wider, the cost to settle the tradesare going to be significantly more, and the commissions that we pay to the broker will be significantly more. So as a portfolio manager we try and balance those costs when we go to trade. I always say that trading is a minus, it's a net cost. So what we try and do is is reduce that cost, and we have some techniques, we have some optimizations, where maybe we don't buy every name in the index, and we just buy a sample that will allow us to track the index. And then the next time we run a list it may be a different set of names, but we'll be able to track the index, and at the same time reduce those fixed costs and spread costs in trading. 

Christine Franquin: And if I can add to that. So when I look at how I started at Vanguard, that was basically my role when I was sent to Europe to create a trading desk, is to find ways to save our shareholders money by improving our execution costs. So really by having a person on the ground you get a good feeling of what is a fair price to pay. You don't pay over charges for that. And then you can really truly look at ways to optimize that spread cost that you have to pay because you know how to source liquidity, who to call, how to use like we have crossing networks, we have closing mechanism, you interact with the market. So those are things that we get to engage with.

Michael Perre: We are active in engaging with both regulators and exchanges to make trading in those foreign markets better and less costly for investors. So we're on a lot of Industry panels. We're on the index committees. We're engaging directly with exchanges, try and advocate for our shareholders and make things better.

Rick Ferri:  Could you talk a little bit about proxy voting. I know that you don't do proxy voting yourself, but how is it done in foreign equities? And I mean do they do it the same way in South Korea or the Philippines that they do in the United States.

Christine Franquin: We, our team--so the team that's managed out of Malvern, but it has persons in actually Australia and in the UK as well, vote every proxy we receive. So basically they have a team that we search what the best option is in the proxy voting to the long-term investor. So that support has not changed. It's the same across the globe. So if you're familiar to what we do for US stocks, we basically do the same thing across the globe. It's more time intensive because it's in different languages and you rely on the custodian to translate the documentation.

But the research and the attention to what is the right vote is the same. We don't necessarily vote in line with the big companies that recommend how to vote. We have our own team and our own analysis. And sometimes we engage directly with the company. So we have a team in London that had like a huge amount of engagement with the company directly, where they sat on the board, they talk about what Vanguard values are, and how we think about long-term value for shareholders in that sense.

And they're pretty engaging to be honest, like we also engage with certain governments. Like last week I was talking to a government in a European country for the same reason. They had questions around proxy voting and how we really want to have a voice for shareholders in their interest.

Rick Ferri: I want to turn now to the ETF and open-end mutual fund. And at Vanguard it's a little bit different. You've got an ETF as a share class of the open-end fund. But the interesting thing about ETFs is that they trade during the day – the foreign ETFs that are covering the Total International Fund, the Emerging Market Fund, the Developed Market fund – these ETFs are trading during the day. Do they trade close to where these futures trade, that you were talking about? I mean when you go to price the NAV of the open-end fund at the end of the day does the ETF pricing, is that any kind of a price discovery vehicle that you're using to help determine what the price of the open-end NAV is at the end of the day. You know, which would be the price that open-end fund shareholders would transact with.

Michael Perre: Sure, ETFs are a great proxy, at least the ones that trade and have significant volume are a good indication of where a market should be priced. So if Taiwan is closed and we need to look at where we should price that market, they can look at a lot of different factors. They can look at ADR’s [American Depository Receipts] that trade in this country. They can look at ETFs, whoever's ETF it is that trades and it's a decent approximation because the people that are making markets in those products want to actually set bid offers that are fair. So they wouldn't want to set an offer that was maybe too low because people could potentially take advantage of it. So ETFs are a pretty good proxy for what we call fair value.

Rick Ferri: I want to stay on ETFs for just one more minute because a lot of investors do use ETFs and when they go to put the order in to buy an ETF or to sell an ETF, if they're putting it in in the middle of a trading day for VXUS or VEU, generally the spread between the bid and the ask is maybe one penny. So it's very tight, and we've been told that you should put in limit orders on what, you know when you're buying you should put in a limit on how much you're willing to pay for these ETF shares. And when you're selling you should put in a limit on how much you should take when you sell your shares. But  it seems to me there is so much liquidity, the pool of liquidity in VXUS and VEU is so large that even when we put in fairly sizable orders you get pricing--- often when you're trying to buy you get pricing even at the the bid price--and when you get– and when you're trying to sell you get the better ask price, which is flip-flopped. But could you comment on that? Because it seems to be very good pricing just by putting in market orders, even though we're told by the ETF experts out there that you shouldn't put in market orders.

Michael Perre: I think it depends on the size of your order. So if you have a really small order you're safe, you’re safe going market. If you have a larger order it probably warrants using a limit order. So for the regular retail investor that's trading less than 100 shares, or 100 shares, or 200 shares, you're probably fine. If you're trading a block or a thousand shares maybe be a little more careful with setting limit orders. Problem with setting limit orders is you subject yourself to something called adverse selection. So if you're on the bid side and the market drops you're probably more likely to get done if it goes through you--so that's not great execution. 

So I'm with you. I think small orders, I think people are fine putting market. I think it's the larger orders you want to use limit orders.

Rick Ferri: I've had some very large investors who have purchased 10 million, and these are retail investors who have a lot of liquidity after selling a business, and so forth and they're buying 10 million dollars of VXUS at a time and I recommend that they call Vanguard to do this. Is that something that you recommend also?

Michael Perre: We do have a Capital Markets area that deals with institutional investors or investors of size. Basically there are market makers in the market that our Capital Markets team will work with to set up what a fair bid offer price would be in the market. So you may have one of the market makers make a price if it's that kind of size.

Christine Franquin: And we also know who owns liquidity. So we know from the market maker, like the authorized participant point of view, which is basically the people transacting in the second market, and really transacting directly with us we know who owns an inventory of those shares. So I can tell you certain brokers that are big names hold a lot of shares of VT, I could tell you like if it's VT or VEU, I know exactly who I will send you to just because of our interaction with them. You know that they have a tendency to interact with in what we call the primary market, which is directly with us by the exchange of shares in-kind. So we could guide you to people we know can make a market for you in that ETF. So that's not a bad call at all because you have that knowledge.

Rick Ferri: Well let's break it down then. If you're going to do less than a thousand shares then it's probably okay to put in a market order. You're going, if you do it during the middle of the day, not at the beginning of the opening, or at the close, but in the middle of the day, when things are trading, that you're probably going to get good pricing. You really don't have to worry about putting in limit orders. But if you're going to put in more than a thousand, then you might want to try a limit order, and see. 

But you know again that sometimes it's difficult, like you said Michael, the market's moving against you, you can end up paying more. But at some point you're going to want to contact the market desk at Vanguard and have them do the trade for you. Would you say that that would be like a 10,000 share order, or more. What do you suggest?

Michael Perre: So I'm not sure what the exact dollar amount is. I think it's more institutional size, so maybe larger than say,10,000 shares.

Christine Franquin: Yeah, I don't think--we don't really trade our own ETFs because we have restrictions in place--so I think we are not…

Rick Ferri: Okay no, that's fine. But it is some much larger amount, and I think if you're going to do a big trade like that multi-million dollar trade, that you would be able to contact Vanguard directly on that and they would help you out. That's if you're custodying at Vanguard. If you're custodying somewhere else you would have to contact the broker that you're working with.

If you had a crystal ball, and I know we don't, in closing tell me your thoughts about the future of emerging markets and the future of developed markets. I mean what do you think?

Michael Perre: Well I can tell you what makes us different than other index desks, and I think we have a little bit more flexibility as portfolio managers because we are also the traders too. So we can identify opportunities in the market that can save costs better than other places. Normally the setup is the portfolio manager gives a trade to a trading desk and the trading desk is incentivized one, to get the order done, and two, not to get done in a way that they would be questioned. For us, since we are the portfolio manager and the trader, it gives us a little more leeway in terms of figuring out how to save costs.

For example, last week there was a share increase in a UK stock. The deal had closed where they were buying a U.S. company, and we were able to buy the exposure of the UK name in the form of a U.S. stock and actually bought it three percent cheaper. Now we have risk areas that keep us in line, so that we don't take undue risk. But it's examples like that where we have a little bit more flexibility than other shops, and we are constantly fighting for every last nickel that's in the market because we know, ultimately, our objective is to get the best returns for our shareholders, give them the best chance for investment success.

Rick Ferri: I have to say that when looking at the performance of all the different international equity index funds that are the total funds, broad market funds, this way you trade, and the low fee that you have, but more probably the way you trade actually does come out in the performance. I see that over a few years compounded that Vanguard always seems to be ahead by maybe 0.1 percent, sometimes a little more sometimes a little less, but in the long term this ability to trade better and get better pricing does show up in the performance. Which is why I tend to prefer, personally, the Vanguard Total Market ETFs.

But at times when I'm doing tax loss harvesting and things are moving quickly and need to move around between different International index funds, you know would move out into something else, but I appreciate very much what you do at Vanguard for all of us. And Christine, do you have anything else you'd like to say before we close?

Christine Franquin: The European markets close around lunchtime. I was trading European markets here in the US and the entire trading desk went for lunch, so I was the only person standing there. Mr. Bogle came through the door, like how are the markets doing, and I was so taken by what I was trading because it's like the peak time for my work, that I started rambling to what the London Stock Exchange was doing what the Europe Next Exchange was doing between France and Germany, and just trying really to articulate the vision of what all the European markets were doing because I was proud of it. And it's Mr. Bogle, and sitting right there, not just very, very young, and I remember his puzzled look, looking at me like “what is she talking about.”

So yeah Mr. Bogle doesn't live in international investing. So you are way way off track.

Rick Ferri: Yeah Jack Bogle had two things that he stuck with, and number one was why do you need international stock. We sell products overseas, we get our exposure that way. That was one of his viewpoints. And the other one was how he hated exchange traded funds. So if you're an international fund manager who's trading the Vanguard ETFs, I mean you're not on his Christmas list, sorry.

Michael Perre: Mr. Bogle, like this--he would come in every once in a while to talk to us during the day and it was a great kind of experience to have him come by and say hello. And he was that type of person. He would go over to the cafeteria and have his peanut butter and jelly sandwich, and he would hold open court to anyone who wanted to sit down and chat with him. He really was a people person, and loved the crew here. So he's missed, no doubt.

Rick Ferri: Well thank you so much for both of you for joining us today on Bogleheads on Investing. I greatly appreciate this discussion and have a great 2023.

Christine Franquin: Thank you for having us.

Michael Perre: Thank you.

Rick Ferri: This concludes this episode of Bogleheads on Investing. Join us each month as we interview a new guest on a new topic.  In the meantime visit Boglecenter.net, Bogleheads.org, the Bogleheads Wiki, Bogleheads Twitter. Listen live each week to Bogleheads Live on Twitter Spaces, the Bogleheads Youtube channel, Bogleheads Facebook, Bogleheads Reddit. Join one of your local Bogleheads chapters and get others to join. Thanks for listening

About the author 

Rick Ferri

Investment adviser, analyst, author and industry consultant


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