Welcome to Bogleheads on Investing, episode number 51. This episode is all about international stock investing. Today, we have two special guests, Christine Franklin and Michael Perry. 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 US.

Hi, everyone. My name is Rick Ferry, 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 boglecenter.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 Franklin, a principal and senior portfolio manager in the Vanguard Equity Index Group, and Michael Perry, 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 Perry 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 Franklin and Michael Perry. Welcome to the Bogle Heads on Investing podcast. Thank you for having us. Thank you. 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 US 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 Bogle Heads 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? 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 US 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 develop more global presence and really represent that global view in the US. And I've been a portfolio manager here for, yeah, probably 10, 11 years now.

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. 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 start to trade and be a portfolio 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 person 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. 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?

Vanguard is my first job out of college. 32 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.

Definitely was a focus to keep costs low. I remember that Jack telling that story. And others at Vanguard telling that same story. It's true. About 25 years ago or so, I got to the trading desk. And I'd been working on both domestic US 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 we went direct. So we've been there from the start. 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 as-- I would say 15 years ago, because I wasn't receiving any of my trades. We had used a couple of different underlying funds. Europe, Pacific, and Emerging was 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. 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% US stocks and 40% international from a capitalization-weighted-- not GDP, but capitalization-weighted. Could you differentiate what makes a US company and what makes an international company? Is it just where the headquarters are located? How is this decided in an index? 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.

Is it safe to say that if you bought a total US stock market index fund and a Total International index funds that all of the securities are mutually exclusive, that there's no overlap? Because there are two different index providers. So I couldn't say 100%. 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. 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? 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 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, 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 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 list. 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 can 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. And 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? 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 US. They have listings in Singapore. The names that are listed in mainland China are capped at 30% 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 then they'll continue to increase the weight down the road.

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, free-float capitalization weighted, which means the stocks that are available for anyone to buy. Is that a fair assessment? 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 state-owning part of certain critical companies, the same thing being the 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 US indices have less of those free-float factors playing a role.

So I just want to understand this. So it's basically the indices that are used in the US are for what US 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 US 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 US investors. Is that correct? It's not to US investors. So if you're looking at the China situation, it's 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 cut-off, actually, that's what's truly available. If you're looking free flow, it 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-holdings. So if you're looking in Japan, you have Toyota buys a lot of their suppliers. They own 30% to 40% of the supplier's chain. That's never going to be available for shareholders of any Japanese or US or 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 weight.

Now, all of the indices are calculated in native currencies. We don't have any currency hedging in the equity market, in the total international fund or the developed market fund or emerging market fund. Unlike our bond funds that we get through Vanguard, the equity funds are unhedged. So basically, if you're 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 out.

So historically, the currency volatility over 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, already 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.

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. There's no currency hedging. The foreign markets I looked at this year, and kind of doing about as well as the US 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%, 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 US market. But I don't think a lot of people realize that international stocks in their own native currencies are actually outperforming the US 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 US market, which tends to be heavy health care and heavy technology.

So in your experience, can you tell us how the 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? It's basic theory in terms of pricing. So if you have cash flows that are in the future, you get 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 the technology companies.

That could be a reason why an index with more financials is doing better once you strip out currency than technology indexes. You also have more basic materials. You have more energy. You have 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 has a tendency to probably have prospect of bringing short-term returns that are higher than in the technology sector for the reason that Mike explained.

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 ones, it seems to be, internationally, have a much bigger allocation to materials, financial services, industrials, energy, and a much lower allocation to health care 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 US 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 PE, price-to-earnings ratio, this is based on September 30th data.

The total US stock market fund 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%.

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. 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.

PE ratios are much less. Price-to-book is much less. We just had currency moves, pretty substantial currency moves in the last few years where the dollar strengthened. So I think our investment strategy group is in agreement that there's probably more opportunity for equity-like returns in international equities than US equity.

Historically, if you go back 30 years and you look at the PE ratios and price-to-forward earnings and so forth, 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 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.

I mean, 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.

Gosh, I mean, I think the Vanguard Total International Index Fund right now is yielding about 4%. True, is that correct? Yes. So I definitely had looked at that recently, and that is true. It's 4%. Well, that's a phenomenal yield. If you're going to just-- if you believe that-- 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, if you 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? So really, 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 our 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 work with the custodian 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 create from your US taxation.

So that's how it works. I just want to make one caveat. A lot of people talk about putting the World Equity Fund in their taxable portfolio. But there is a little quirk in the IRS tax code-- and again, I'm not a tax expert either-- that says that 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 US Total Stock Index Fund and the Total International so you could get the tax credit from the international fund. So I wish I could say that you have the same tax advantage in Total World as you have in Total International.

But it's different just because Total World has 60% of its asset invested in US security. So we don't get the tax credit back through Total World. So you're probably, from a tax perspective, better off choosing to use Total Stock and Total International to get the same exposure. 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 Bingard Total International Stock ETF follows the FTSE Global All Cap Ex-US Index, which has 7,991 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. 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 VEU. So please explain that.

So Global All Cap, VXUS, is exactly that. It's all cap. 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% 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.

OK, this is interesting because I also looked at your competitor, iShares, and they follow the MSCI ACWY Ex-US IMI Index. That has 4,300 names in it. And then Fidelity has a Total International Fund, and they follow the MSCI ACWY Ex-US Investable Market Index. That has 5,045 names in it.

Fidelity also has the Fidelity Zero Fund, Total International. They call it, but it only has 2,458 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 8,000.

And all of the rest of them have at least 3,000 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. Yeah, so the difference is methodology. And the methodology is that FTSE actually has more names in the index, because their cutoff 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'll accept in our index. So the result is FTSE's thresholds for index entry are a lot smaller in terms of market cap than a lot of the other global markets.

You have companies that are $100 million to $200 million market cap in terms of size, where MSCI cuts it off at about roughly $300 million. And it seems that even though the correlations between these funds are 0.99, or the R-squared is 99, it's very, very, very close, that in fact, there are these very, very, very minor differences.

I looked at the 10-year performance, the Vanguard FTSE All World XUS and the Vanguard Total International Stock ETF over a 10-year period of time, ending in September 30th. And the Vanguard FTSE All World XUS ETF compounded at 3.32%, 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're going to-- 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 XUS. It is a different index. It is a different fund.

It has a different QCIP. 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. Yeah, I would agree. I think methodology across all of the indexes conformed over the years.

So everyone has load adjusted. Everything's based on market cap. Very similar methodologies in terms of when to include IPOs or secondary offerings. So it doesn't surprise me that the returns have been pretty similar. Well, I want to get into how you do your jobs now. I mean, you're in the US.

You're trying to come up with an NAV at the end of the day for the Opened End Fund. The ETF is trading in the US 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? European market closed around 11.30 AM. So after 11.30 AM, basically, the only thing that's really investable is Canada and Latam, which is a very small portion of that portfolio.

So if we get any cash flow, 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 create trading days 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 have that presence across the globe. We have presence in London. We have presence in Melbourne, in Australia.

And we actually ask 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 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 they're trading. Yeah, just to confirm what Christine said, we rely on the local expertise of our trading desk. We have one in the UK, one in Australia.

They've become experts in those markets. So they are trying to save as much cost 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. So transaction costs are huge. And it's like saving that nickel in the copier machine. We're trying to add the same costs around the edges. And ultimately, it means better returns for our investors. Michael, could you elaborate on transaction costs?

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 hold the fund from a transaction standpoint? So in terms of commissions, commission rates we get in the US 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 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 costs to settle the trades are 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 reduce that cost. And we have some techniques. We have some optimizations where maybe we don't buy every name in the index.

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.

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 the trading desk, is to find ways to save all 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 overcharges 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-- we have crossing networks. We have closing mechanism. You interact with the market.

So those are things that we get engaged with. We are active and 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 to try and advocate for our shareholders and make things better.

Can 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 do they do it the same way in South Korea or the Philippines that they do in the United States? We, our team-- so the team that's managed out of Maverick, but has presence in, actually, Australia and in the UK as well, vote every proxy voting.

So basically, they have a team that research what the best option is in the proxy voting for the long-term investor. So that approach 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 have a huge amount of engagement with companies directly, where they set up 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 truly engaged.

And to be honest, we also engage with certain governments. Like last week, I was talking to a government in a European country for the same reason. They have questions around proxy voting and how we really want to have a voice for shareholders in their interest. 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, which would be the price that open-end fund shareholders would transact with?

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 ADRs 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 and 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. 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-- when you're buying, you should put in a limit on how much you're willing to pay for this 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 bid price. 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. 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 1,000 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. I've had some very large investors who have purchased $10 million. I mean, these are retail investors who have a lot of liquidity after selling a business and so forth. And they're buying $10 million of VXUS at a time.

I recommend that they call Vanguard to do this. Is that something that you recommend also? 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. And we also know who holds liquidity. So we know from a 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 if it's VT or VA, I know exactly who I will send you to. Just because of our interaction with them, we know they have a tendency to interact with 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 we have that knowledge. Well, let's break it down then. If you're going to do less than 1,000 shares, then it's probably OK to put in a market order.

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, then 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 1,000, then you might want to try a limit order and see. But again, sometimes it's difficult. Like you said, Michael, the market's moving against you. You could 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? So I'm not sure what the exact dollar amount. I think it's more institutional size, so maybe larger than, say, 10,000 shares. Yeah, I don't think we-- we don't really trade our own ETFs, because we have restrictions in place.

So I think we are not. OK, 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, a trillion-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. What do you think? Well, I can tell you what makes us different than other index desks.

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 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 US company.

And we were able to buy the exposure of the UK name in the form of a US stock and actually bought it 3% 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. 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%, 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, 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?

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. Vogel 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 through what the London Stock Exchange was doing, what the Euronext Exchange was doing, 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. Vogel and sitting right there, and I'm just very, very young. And I remember his puzzled look looking at me like, what is she talking about? Yeah, Mr. Vogel doesn't believe in international investing. So you were way, way off track. Yeah, Jack Vogel had two things that he stuck with.

And number one was, why do you need international stock? We sell product 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 a international fund manager who's trading the Vanguard ETFs, I mean, you're not on his Christmas list.

Sorry. Mr. Vogel liked us. 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. Well, thank you so much for both of you for joining us today on Vogel Heads On Investing.

I greatly appreciate this discussion. And have a great 2023. Thank you for having us. Thank you. This concludes this episode of Vogel Heads On Investing. Join us each month as we interview a new guest on a new topic. In the meantime, visit vogelcenter.net, vogelheads.org, the Vogel Heads Wiki, Vogel Heads Twitter.

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