Vanguard Growth And Income Fund: It Hasn't Been Able To Beat The S&P 500 For A Good Reason

| About: Vanguard Growth (VQNPX)

Summary

VQNPX uses very similar sector allocations to the S&P 500.

The holdings don’t seem like unwise choices, but the expense ratio makes it difficult to believe VQNPX can beat SPY over the longer periods.

An analysis of the last 16 years demonstrates what investors should expect; VQNPX loses to SPY by a bit less than the difference in expense ratios.

The mutual funds offered by Vanguard are often on my short list for the best mutual funds available. Vanguard is known for low cost index funds that are able to track their indexes exceptionally well. As I was browsing their fund lineup recently I decided to take a deeper look at the Vanguard Growth and Income Fund (MUTF:VQNPX). This is one of Vanguard's funds that attempts to do more than match the index. The goal for the mutual fund is outperforming the S&P 500. That idea sounds great, but an expense ratio of .34% creates a substantial challenge for a mutual fund that will aim to beat the S&P 500 while following the returns fairly closely.

Holdings

I put grabbed the following chart to demonstrate the weight of the top 10 holdings:

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I don't mind this holding chart at all.

Apple (NASDAQ:AAPL) being the top holding makes sense for a mutual fund that wants to more closely track the market since Apple is such a large part of the market. While VQNPX is attempting to beat the S&P 500, they also want to remain fairly close in returns so that the difference would be a marginal outperformance. Since this requires more management, I can't see any reason for investors to intentionally reduce the allocation to Apple. The company has an enormous amount of cash on hand and still trades at a P/E ratio below 12. If we removed the cash and dropped the market capitalization by the same amount the resulting P/E ratio would be under 11. For a company with a strong history of innovation, investors have shown little faith in continued performance.

I love seeing Exxon Mobil (NYSE:XOM) as a top holding. Investors may be concerned about cheap gas being here to stay, but I think money in politics will be around decades (centuries?) longer than cheap gas. Bet against big oil at your own peril.

Similarity of Sector Allocations

I put together the following chart to compare the sector allocations between VQNPX and the S&P 500 ETF (NYSEARCA:SPY):

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The sector composition is extremely similar which suggests that results would also be very similar over time. For the mutual fund to beat the S&P 500 it will need to either have substantially better performance by the sectors it gives heavier weights to, or it will need the individual holdings to beat the rest of the S&P 500 portion of that sector.

Since the sector allocations are so similar, the ability for sector performance to power VNQPX to stronger returns than the S&P 500 is severely limited. The result is a reliance on individual allocations within each sector to outperform their peers. This may be possible in theory, but it is putting a substantial amount of eggs in the basket of managers attempting to pick the right stocks.

Over 15 Years of Performance

One of the fastest ways to check the total returns on tickers is to just run it through Investspy. I used that technique to test the difference in returns so far this century and it turned out to be roughly what investors would have expected if they don't believe in higher fees leading to better performance:

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If we annualize those returns we find that SPY produced a CAGR (compound annual growth rate) of 4.1425% and VQNPX produced a CAGR of 4.0087%. The difference in the CAGR is .13% in favor of SPY. That seems like about what investors might expect from a glance at the expense ratios. The .34% for VQNPX is .25% higher than the .09% on SPY. Of course, expense ratios may change over time, but I would expect roughly similar performance going forward. I expect similar total returns with VQNPX lagging slightly due to the higher expense ratio. Slightly better allocations due to active management may strengthen returns, but I wouldn't expect it to strengthen them enough to offset a difference of .25% in expense ratios.

Mutual Fund Difficulty

Another challenge for the mutual fund is the nature of redemptions. VQNPX will occasionally need to carry a small portion of the portfolio in cash to handle redemptions during periods marked by heavy selling. That could mean slightly less equity invested when the recoveries begin and the result would be a slight drag. All things considered, only falling behind SPY by .13% is fairly impressive. Unfortunately, it doesn't give investors a strong reason to take VQNPX over lower fee alternatives.

Conclusion

This is a fine mutual fund and it performed admirably given the headwinds it faces. However, it would make more sense for investors to choose a more passive mutual fund with a lower expense ratio if they have the opportunity for allocations within a 401k. Attempting to track the S&P 500 and beat it with similar sector allocations simply creates too much of a burden when the difference in expense ratios is .25%.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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