Commentary

Vanguard announced on October 30 that it is increasing its purchase fee in its emerging-markets mutual funds from 0.25% to 0.50%. The fee increase is to ensure that new investors, rather than the entire firm's existing shareholders, bear the costs of Brazil's recent 2% inflow tax on foreign investments in Brazilian equities or bonds. While the fee impacts all mutual fund classes, it does not apply to the firm's emerging-markets ETF, Vanguard Emerging Markets Stock ETF.

The reason Vanguard is not increasing the fee for the ETF is that transaction costs for buying and selling Brazilian stocks are not the burden of the firm. Rather, transaction cost burdens are held directly by a third party, the authorized participant, that creates new share baskets when the fund experiences net new inflows of investment dollars.

While any frictional costs, like Brazil's inflow tax, are a negative for investors, there is a smaller offsetting positive for current emerging-markets ETF shareholders. ETF shares are most often traded among investors, unless there are net inflows or outflows of funds. When the open interest in shares changes, the APs create or redeem shares of the ETF in exchange for the actual basket of stocks. In order to provide sufficient incentive for APs to go through the arbitrage process of creating new shares, new baskets will likely be created only when a sufficient premium in the ETF exists that covers the higher inflow transaction costs. In a nutshell, we would expect a somewhat larger premium over net asset value to occur in the emerging-markets ETFs when interest in Brazilian investments increases.

Paul Justice, CFA has a position in the following securities mentioned above: VWO

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