- VOT’s investment mandate is to track the CRSP US Mid Cap Growth Index.
- The principal issue with VOT is that despite its seemingly mid-cap focus, over 96% of its net assets are invested in 170 companies with market capitalizations above $10 billion.
- VOT has a large exposure to growth but terrible valuation.
- VOT did deliver superb returns in the past, trouncing IVV in 2020 and 2019, with 2012, 2013, 2014, and 2017 returns on par with the bellwether ETF. It failed to beat the blue-chip index last year, partly because of the capital rotation.
- I opt for a Hold rating.
Today, we are discussing yet another exchange-traded fund, with an article on the Vanguard Mid-Cap Growth ETF (NYSEARCA:VOT), a fund with total net assets of around $25 billion.
The mid-cap echelon is supposed to provide plentiful opportunities, especially for investors seeking outsized revenue growth prospects that should translate into capital gains in the future, as stock prices will be trying to match the intrinsic values based on future free cash flows. On the negative side, the size discount stemming from higher risks inherent to the small/mid-size echelon can weigh on returns, with relatively low quality (which is oftentimes rather fickle, if we are talking about companies with nascent growth stories) also being a possible headwind.
However, the principal issue with VOT is that despite its seemingly mid-cap focus, over 96% of its net assets are invested in 170 companies with market capitalizations above $10 billion; as of my estimates, the weighted average market cap of its holdings is around $34.4 billion, while the median is approximately $24.2 billion. Another way of saying, in the current iteration, VOT is a large-cap ETF, though without exposure to the mega-caps and the $1 trillion league. In the top ten cohort, all the companies have market caps close to or well above $50 billion, with ~$74.7 billion Marvell Technology (MRVL) being the most expensive. So, please beware of exposure you probably do not want.
Turning to the ETF grades, this fund has an overall neutral mix, with none of the five ratings signaling caution. First and foremost, VOT offers an exceedingly comfortable cost structure, with a razor-thin expense ratio of only 7 bps, which makes it one of the cheapest investment vehicles in the class. Its Momentum is rather soft, as the capital rotation has taken its toll, but not totally dreadful, with bright spots like the 3-year and 5-year total returns. Nothing spectacular with Dividends as the distribution yield is only 34 bps, far below the class median of ~1.2%, with all the CAGRs except for the 10-year one being below zero. But I believe investors seeking exposure to mid-size growth stocks likely are not that interested in sizeable dividend income since capital appreciation is of greater importance to them. Dissecting the VOT portfolio (as of November 30, the most recent data available), I found out that just 72 stocks have a dividend yield (~64% weight), while 48 of them have this metric below 1%, which is consistent with them having lackluster Quant Valuation grades (yes, they do trade with sometimes insanely overstretched multiples). Underlying metrics for the Risk grade are mostly fine, except for standard deviation and short interest. Asset Flows are also adequate, thanks to solid trading volume and healthy AUM changes.
VOT’s investment mandate is to track the CRSP US Mid Cap Growth Index. As detailed on page 32 of the methodology, the index provider considers two forward-looking factors, namely future long-term and short-term EPS growth, two historical: 3-year EPS growth, 3-year sales per share growth, as well as current investment-to-assets ratio and Return on Assets.
Securities are allocated to capitalization-based indices according to the rules explained on page 9 of the document. These rules are the main culprit of VOT being overweight in large caps despite its mid-cap focus.
As of November 30, VOT had 187 stocks in its portfolio. Risks are relatively adequately dispersed as the top ten holdings accounted for just 13.4% of the net assets. Technology and industrials were its two key sectors with 31.4% and over 18% weights, respectively.
As I said above, VOT is essentially a large-cap ETF, so please do not be surprised by the fact that its holdings overlap with the iShares Core S&P 500 ETF (IVV) is over 65%. But if we compare the MDY and VOT datasets, we will find out that the overlap between the two is … approximately 0.4%, thanks to IBKR, CGNX, and SEIC being present in both. MDY is another mid-cap fund that I cover, with the most recent note published in October. Should we compare the iShares Russell 2000 ETF (IWM), another investment vehicle for small/mid-cap exposure? I believe with should. And the overlap is … simply non-existent. Please take notice that I calculate the overlaps by myself, comparing the most recent datasets from the fund’s websites.
Digging deeper, it is also worth mentioning that the table from November 30 shows VOT was long Kansas City Southern (traded with a ticker KSU) that is no longer public because of its merger with Canadian Pacific Railway (CP). Another stock in its portfolio that has been delisted in the wake of acquisition is PPD (traded with a ticker PPD) bought by Thermo Fisher Scientific (TMO).
A closer look at factors
Now, let us discuss factors. How VOT’s holdings are valued? Is there a margin of safety, perhaps?
Unfortunately, most of them are valued terribly. As my analysis of the Quant data illustrated, over 84% of VOT’s net assets are invested in stocks with Valuation grades of D+ or worse, with those in the F club sporting almost 36% weight, like HubSpot (HUBS) and Xilinx (XLNX). A few value stocks can also be spotted, but their weights are diminutive, only ~3.6%. I have not expected anything different from a growth fund.
Next, quality. For a fund focused on mid-size stocks, I typically anticipate around 60% of the net assets allocated to stocks with Profitability grades of B- or better. E.g., MDY had ~67% in October. But VOT has close to 82%, with only ~8.6% allocation to those with lackluster quality. This is consistent with what I discussed a few times last year: large size correlates with high quality.
Now, probably the most interesting part. Do companies that VOT favors actually grow? This part of the analysis has positively surprised me. First, using the dataset I downloaded using the screener, I found out that ~37% of companies inside the fund portfolio are forecast to deliver no less than 20% forward revenue growth (in my view, a level decent enough to qualify for the top growth club). Meanwhile, those that have already delivered over 20% YoY growth have a 58% weight. Of course, there are companies with much stronger profiles, like Okta (OKTA) with a close to 50% YoY rate. Speaking of the sales dynamics in the past, around a third of stocks have 3-year revenue CAGRs greater or equal to 20%. Turning to EBITDA, around 65% of the holdings are forecast to improve this metric by at least 10%, including Lululemon Athletica (LULU). Still, VOT does have exposure to unprofitable companies that pundits anticipate remaining loss-making in the medium term, incapable of delivering even thin EBITDA, let alone EPS, with Lyft (LYFT) being an example.
I always encourage my dear readers to do their own due diligence before making investment decisions, and when it comes to ETFs, read methodologies, prospectuses, and analyze holdings datasets, if available. In the case of VOT, the primary conclusion is that this ETF is nothing but a large-cap growth fund. It does not have exposure to the tech titans that seized the leading positions in the S&P 500, and thus might be a decent choice for growth investors who are seeking exposure to large-cap echelon, but without a footprint in the mega-cap league. Still, only 15 companies in its portfolio have market values below $10 billion, like NovoCure (NVCR) and Opendoor Technologies (OPEN).
So, for investors who are on the lookout for large-size companies with robust quality, outsized revenue growth (with EBITDA growth not necessarily supervening), regardless of valuation, VOT is a fund to consider.
VOT did deliver superb returns in the past, trouncing IVV in 2020 and 2019, with 2012, 2013, 2014, and 2017 returns on par with the bellwether ETF. It failed to beat the blue-chip index last year, partly because of the capital rotation.
Source: Portfolio Visualizer
Overall, its 10-year CAGR is around ~16.5%, while IVV has ~16.1%, as calculated by Portfolio Visualizer.
But we do not know what the role monetary policy played in its bullish run, especially in 2020. More likely, the essential one. Hence, with the higher interest rates in the cards, the growth premium the fund’s valuation currently has can become well lower. I opt for a Hold rating.
This article was written by
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