Vanguard Funds PLC (VGRRF): Best Traded Through London – Except, Maybe…

Vanguard does funds

As we all know. Vanguard does funds of varying types. One mimics the FTSE100, largely by being made up of physical holdings of the component parts. It’s not exact but it’s very close to actually being a mirror of that index. We can see all the lovely technical details, if we wish, here. There are, for example 103 holdings to mimic a 100 index – it’s not exact!

The point of this piece is not to suggest low load index funds as a method of investing. We all know that for the unsophisticated investor this probably is the way to do it, stick some money into this sort of – please note, not necessarily this one – fund and wait 30 years. We’re not unsophisticated investors around here so that sort of level of advice isn’t all that useful to us.

However, there’s still something of interest to us here.

What interests us is this

There are three (actually, there’s a Mexican quote as well but that’s not germane here) for this specific Vanguard fund. There’s (LON:VUKE), the main quote, then there are two US quotes, (VUKEF) and (VGRRF). The two American quotes are listed here and here on Seeking Alpha. Vanguard themselves probably aren’t really sure what those US quotes are about. They’re definitely not their own, they’re issued by brokers and something about trading and flow and mutter mutter.

What interests us is that trade in them must be exceedingly thin. For as we can see from those share price movements they’re not tracking the London quote in the slightest. Or rather, they stay static for months on end and then move in $3 and $4 lurches. Now that’s interesting.

Even Vanguard themselves probably don’t know whether those US stocks are fully fungible into the London stock. Clearly, the prices should shadow it – they don’t, as above – but whether they’re deliverable, well, we don’t know. That doesn’t particularly matter for the thing that’s of interest here.

We’ve got three things that should be the same price – they’re not, or often they’re not. So, there should be money to be made here. It’s arbitrage, of course, but of a specific and sadly very limited kind.

Our problem is that the trade in the US is very thin indeed. That’s why the price differences open up – no one’s bothering to trade it. But if anyone trades in any volume then the market makers will wake up and the price difference should disappear.

Why there’s little to no trading should be obvious enough. We’ve a liquid London ETF, denominated in sterling. If you wanted to track the FTSE100 in any size but in $ then you’d be better off buying in sterling then covering the £/$ exchange. Or even buying direct into one of the ETFs that track FTSE but in $. Instead of being in a highly illiquid $ version of the same ETF. So, that it’s not liquid is why it stays illiquid.

As to actually investing here

Sure, there’s nothing wrong with an index fund. We should note that it looks like even Vanguard themselves get this particular ETF wrong though:

• The index is a capitalization-weighted index of 100 UK companies.
• The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of the index that represents the major industries.

Err, no. The FTSE100 is the capitalization-weighted index of the largest 100 companies listed in London, not in the domestic economy. Some constituents have near nothing at all to do with the UK economy (umm, Anglo American?), some are nearly entirely within it (Admiral?) some are a bit in and a bit out (Astra Zeneca) and that’s just the As.

Actually, 75% of the revenue – and profits – of the FTSE 100 index comes from outside the UK and also outside the sterling area. This has the perverse effect that when the UK economy falls, then so does the £ exchange rate, the FTSE index (note, from this effect only, obviously other things can happen at the same time) then rises. As the £ value of those foreign earned profits now rises.

Really, don’t invest in the FTSE100 as an index of the UK economy. The FTSE250 is closer, but even that’s 50% foreign revenues.

Our little opportunity

But we’re not really talking about that London quote and long term investing. It’s those two US quotes that interest. They’re both highly illiquid, as above, and as can be seen by their price movements.

Now, whether this can actually be done does rather depend. I think it can, but I’m not absolutely sure. I have one of those background bits of information, no one really quite ever recalls where they come from, that orders under $200 tend to just get filled. No one – no one live that is – at the market makers bothers to check that the quote is right, the ‘bots just fill it.

So, if the quotes move out of line it might – might – be possible to slowly build a little position. It’ll be trivial, more a matter of beating the system for the joy of it than anything else. For it would have to be 3 pieces of stock here, 5 there and so on.

Then, once a position has been built at these “wrong” prices put in an order for 200, or 1,000 pieces. If the market maker is willing to supply at these still wrong prices then excellent. But more likely is that a human will check against London and so the price will jump – as with the VUKEF on 09/10 this year – by 10% or more to accord with London. At which point the position that has been built can be sold back and the profit taken.

I need to be clear what I mean here. This is not an exhortation for people to leap into producing a speculative move in market prices. Quite the opposite. The “correct” price is that London price, where all the trade is. The possibly, potentially, incorrect prices are in these American securities.

It is precisely and exactly people trading on those American prices which should lead to convergence with that correct price, the London one. The only – well, possibly the only – reason for the price divergence in the first place is that trade is so small that people aren’t checking prices properly – the market makers aren’t. A rise in trade won’t produce a speculative bubble but it might wake up those market makers. That’s what I am suggesting at least.

For note what my base position is – the London price tracks the FTSE100 – as it should. The pricing anomalies are in these illiquid US securities. More liquidity should lead to price convergence with London.

Risks

There are, of course, risks about this. The securities mentioned – except the London quote – are hugely illiquid. So, there are all the usual caveats about being in anything illiquid. But of course this gets worse. For if all Seeking Alpha readers decide that we’re goin’ to get us some of this then prices will be all over the place. The weight of money might move prices anywhere – which is that risk of illiquidity again.

It’s possible to mutter something about how more liquidity gets rid of the pricing anomaly but that’s something that would happen over time, as trades went on either side. There’s significant risk of price distortion the wrong way, or to excess, in something so illiquid.

So this is not, not really, about something that a large position can be taken in. It’s about whether there really is a pricing anomaly here which can be successfully arbitraged in small volume. Possibly very small volume.

Again, risks and speculation

This is not about taking risk in order to move prices. This is not about speculation at all. It’s entirely the opposite. There are risks simply because this is all about illiquidity and trading in anything illiquid carries risk. But our point here is that these prices should all be the same. They’re not. So, there’s a possible trade in arbitrage to make them the same.

My view

Yes, agreed, this is slightly contrived. It’s a lot more about having fun with The Man than it is a major investment plan. But then it’s also true that exactly these sorts of anomalies are where we can beat the market. We’ve three listed stocks which should all have exactly the same valuation. They don’t always do so. The big traders simply will not be interested as the moment anyone tries to deal in size the prices will converge. It’s only, only, if we can pick off small amounts without moving the price that it would even be possible to profit here.

So, perhaps worth trying.

The investor view

This really isn’t going to build a pension plan or anything. But then if that’s what we’re trying to do we should be just buying index funds anyway. However, there is this little anomaly we can see from those price movements. The London quote moves in lockstep with the FTSE100 itself, as it’s designed to do. The two US quotes don’t, they appear to be hugely illiquid. There appears to be near ‘free’ hundreds of dollars that can be had from trading, exploiting this. Well, hundreds is hundreds, right?

The reason this won’t work is that it’s not possible to pick off small volumes of stock at those objectively wrong prices. But then that’s the thing to test out, right?