This week we learned that Vanguard will over some index ETFs to combat ETF funds from the iShares family. Specifically, mutual fund giant Vanguard plans to offer exchange-traded funds, or ETFs, on a series of Russell and S&P indexes. These ETF funds include the S&P 500, and challenges the dominance of Barclay’s iShares unit.

This is a Vanguard marketing move, plain and simple.Vanguard doesn’t need another series of large-cap (S&P 500, Russell 3000 and Russell 1000), mid-cap (S&P 400) or small-cap (S&P 600 and Russell 2000) ETFs. In fact, the investment company has long argued that the methodology used to create the MSCI indexes it uses for its current Vanguard Large Cap Index (VLACX) mutual fund, Vanguard MidCap Index (VIMSX) mutual fund and Vanguard Small Cap Index (NAESX) mutual fund — as well as their growth and value subsets and the ETFs based on them — is better than the methodology used by S&P or Russell.

In a paper written when Vanguard was moving toward a shift from the S&P index benchmarks it had been using to the MSCI indexes it now uses, Vanguard’s chief investment officer, Gus Sauter, wrote that growth and value indexes “measure the wrong set of securities or, if not that, then the wrong way of managing those securities.” In his view “an index must reflect the way that money managers actually invest.” Vanguard has also stated that the MSCI indexes “have superior construction and rebalancing methods.”

It didn’t hurt that Vanguard found a “better index” about the time Standard & Poor’s sued to prevent Vanguard from issuing ETF shares on Vanguard 500 Index (VFINX), Vanguard Growth Index (VIGRX) and Vanguard Value Index (VIVAX) all of which were based on S&P index benchmarks at the time.

Vanguard has now been given carte blanche to issue ETFs on the vaunted 500 Index as well as to issue new ETFs on the same S&P indexes it was once prevented from tracking.

A few things that haven’t been focused on in the discussion of this announcement:

• So far there’s only been one opportunity for direct ETF-to-ETF comparisons between Vanguard and iShares, and Vanguard has won. Comparing Vanguard Emerging Markets ETF (VWO) against iShares MSCI Emerging Markets ETF (EEM), two emerging markets index ETFs that track the same MSCI index, Vanguard’s VWO has consistently come out ahead due to lower expenses and tighter tracking. Once Vanguard has its S&P and Russell ETFs up and running, the inevitable comparisons will begin, and over time I would expect to see a major shift of assets towards Vanguard’s stable of products if their experience with the emerging markets ETF is a harbinger.
• Except for Vanguard Global ex-U.S. Real Estate, there are no new investor class open-end funds being launched. There will be institutional funds, but with extremely high minimums. Individual investors will only be able to invest through ETFs, and to do so without paying a commission, they’ll have to do it at Vanguard, where trading in Vanguard ETFs is now free. Smart move! This is a great means of collecting assets under the Vanguard umbrella and builds their direct client base.
• The new municipal bond index ETFs are almost certainly going to be a very popular option for individual investors as they will be cheap to use and to buy (free!), and they are coming at a time when no one ETF provider really dominates this segment of the market. The wrinkle here is that Vanguard will be “sampling” rather than “replicating” the benchmarks it tracks—something that got it into trouble one year with its taxable bond index funds, but which was eventually remedied. Expect these ETFs to gain assets fairly quickly.
• Finally, the new Global ex-U.S. Real Estate is an intriguing expansion of Vanguard’s sector fund offerings and could pave the way for more non-U.S. sector ETFs down the road.

While Vanguard hasn’t put a set date on the launch of these various ETFs, filings with the SEC suggest they won’t be appearing before mid-September at the earliest. This gives iShares a little time to figure out how they are going to combat this attack.