VIG: Investors Can Do Better In The Current Inflationary Environment

Summary

• Even though VIG has had good years, the fund has underperformed the S&P 500 and is currently underperforming several funds that are better positioned in today's inflationary environment.
• This fund is heavily underweight inflation because of the low exposure to commodities, and holds no energy stocks.
• Dividend and Income investors can find better performing funds that offer better inflation protection in today's investing environment.

Nastassia Samal/iStock via Getty Images

Investing in 2022 isn't getting any easier. With inflation consistently running above 5% according to the consumer price index, many indexes such as the S&P 500 (SPY) at or near record highs, and yields on funds and stocks the lowest these payouts have been in some time, investors are having to work harder than in previous years.

One of the most popular ways to invest is through exchange traded funds, or ETFs. Some of the most popular exchange traded funds are dividend and income-based funds, one such fund is the Vanguard Dividend Appreciation Fund (NYSEARCA:VIG).

This fund has nearly $64 billion under management and seeks to match the performance of the Nasdaq US Dividend Achievers Select Index. The fund focuses on large-cap companies. The fund is well-diversified with 270 holdings, the largest 5 holdings are Microsoft (MSFT), JPMorgan (JPM), Johnson & Johnson (JNJ), UnitedHealth Group (UNH), and Procter & Gamble (PG). The fund's holdings are 17% financials, 16% industrials, 15% technology, 15% consumer defensive, 15% health care, 10% consumer cyclical, 5% basic materials, 3% utilities, and 2% communications.

The fund has performed reasonably well over the last 5 years compared to other dividend funds and the S&P 500, offering investors solid income and total returns.

Data by YCharts

The average dividend growth rate of the fund over the last 10 years has been 9.26%, average dividend growth over the last 5 years has been 9%. The current yield is just 1.75%, and the dividend is paid out quarterly. The fund's expense ratio is good at .06%

This fund has performed reasonably well compared to other funds and benchmarks, even though other dividend-based exchange traded funds such as the Schwab U.S. Dividend Equity ETF (SCHD) have performed better, and this fund has also underperformed the S&P 500 as well. The Schwab dividend fund has outperformed the Vanguard fund by 10% over the last 3 years. When you consider both income and total returns, the Schwab fund is up 65% while the Vanguard fund is up 55%. This Vanguard fund has also underperformed other funds this year that are more overweight inflation, such as the WisdomTree U.S. High Dividend Fund (DHS), and the Virtus Real Asset Income ETF (VRAI). The WisdomTree fund currently yields 2.78%, and the Virtus Real Asset Income fund, a real estate fund, currently yields 3.39%.

Investing is about the future, not the past, and this Vanguard fund is likely to underperform other exchange traded funds that offer more protection such as the Vanguard High Dividend Yield ETF (VYM), a fund that is more heavily overweight the financial and energy sectors. The Vanguard High Dividend Yield fund has 22% of its holdings in the financial sector and 13% in energy and basic materials.

Inflation has consistently been at 5% or higher for over a year now as measured by the consumer price index. With wages rising, supply chain issues continuing, and geopolitical tensions high, high prices in many sectors are likely here to stay.

Inflation Data (US GOV)

Inflation has been running over 5% for over a year, and there is no reason to think inflation rates will drop significantly anytime soon. Inflation has been at over 6% for much of this year, and this fund has underperformed most leading dividend funds this year, returning negative 4.9%.

The Vanguard Dividend Appreciation Fund is overweight the financial sector, an industry obviously likely to outperform in an inflationary environment as rates rise, but this fund has no exposure to energy stocks, and very minimal exposure to commodities as a whole, since only 5% of the fund's holdings are in basic materials. This fund does have favorable exposure to a weak dollar because the fund is exclusively large-cap holdings, so there is a lot of international leverage, but this is still an investment that is likely to significantly underperform other dividend funds more overweight energy and basic material stocks. This fund is not likely to perform well in an inflationary environment such as the one we are in, and the Vanguard fund has also been volatile for an investment vehicle heavily overweight defensive sectors such as health care and consumer defensives, with a beta of .88.

With rates still low and likely to remain low for some time, many investors are being forced to be more creative to get the same returns these individuals have gotten in previous years as indexes and funds hit record highs. Even though this Vanguard fund has performed well over the last 5 years, investors seeking stable income and solid returns in an inflationary environment are more likely to be better positioned to get inflation-adjusted returns by picking investment funds that are more heavily overweight commodities and basic materials than this investment vehicle. Funds such as the WisdomTree U.S. High Dividend Fund offer better current yields and are better positioned to offer inflation-adjusted returns in the current economic and investing environment.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Comments

[SenBiden]

Take a look at VIG's holdings, not just the top 10 but the top 70 or so. There are more than a few contributors on SA who make a living writing articles on DGI stocks from the VIG holdings. I've looked there myself for ideas for the past 15 years. Great place to start to look for stocks that provide yield and growth. It outperforms in the long run especially through down markets. I don't own it for the yield but I have made several tens of thousands on this ETF, more than any other.

[Bob Bailey]

I have held VIG for several years. I have gotten good dividend growth and good total return. This has happened because the corporations in VIG have provided strong sales growth and strong earnings growth. I do not just view VIG as a dividend growth fund. Instead, I view it as a collection of most of the biggest and best corporations in America. Over 90% of these companies have moats. I'm confident that they will figure out how to profitably cope with what the future brings.

[eman73]

I purposely avoid funds that have exposure to oil.

[whoisjohngaltmn]

@eman73 thanks for sharing

[LostinShalimar]

@eman73 I purposely invest in funds that have exposure to oil.

[Skillsbury]

@eman73 I purposely invest in funds with exposure to oil, and then top off the 50 gallon tank on my diesel truck and drive around aimlessly at 100mph to get the lowest gas mileage possible (~3mpg). As long as oil stays above $90/barrel I’m making money. If it drops below that I’ll continue to bathe in 10W-30 regardless.

[dgi123]

Thanks for this article. I'm confused about a few points.

You say "Investing is about the future, not the past". I agree. Historically, SCHD has given slightly better returns, but going forward I prefer VIG. SCHD has more traditional companies like CSCO, IBM, VZ in the top 10. Those companies are okay but they don't grow their earnings as quickly as companies like MSFT, V, UNH, or COST in VIG. Yes companies like VZ are definitely value plays, but over the next 10 years, I anticipate the companies in VIG to give better total returns

You say VYM is a better pick because it is over weight financials and energy which will obviously outperform in higher inflationary environment.
I would argue this is already priced in. BAC is trading at record high valuations: P/B is the highest it's been for 10 years. Same for JPM except for the past 2 months. And oil companies like XOM and CVX are also near all time highs. As soon as russia calms down and global oil production is back to normal, these companies will return to normal prices as well

[Skeptical12]

@dgi123 I disagree, China has open their economy yet and oil prices were high before the Russia-Ukraine conflict, which may persist for years. Oil companies will do very well and oil companies will pay very good dividends even if oil prices drop 15-20% from today's levels.

[D.S. Leach & C.E. Leach]

@Skeptical12

I currently hold a sizable position in VDIGX (original mutual fund sister to VIG). VDIGX has performed marginally better than VIG over the last year.

I'm well aware that most advisors warn against market timing but....

Given the Fed has signaled (in flashing red neon) raising short term rates over the balance of this year, major indexes near their all time highs, and increased prospects for a recession, is now the time?

[Psycho Analyst]

@D.S. Leach & C.E. Leach VDIGX is very different from VIG. It is an actively managed fund run by Donald Kilbride. Its stocks are hand picked and it only holds a small number of those stocks. VIG is algorithm-driven and uses a very simplistic algorithm that misses many factors that would be important to VDIGX. It holds hundreds of stocks.

The big problem with VDIGX, which I used to own, is that it pays off large, taxable capital gains each year making it a poor holding for a taxable account. It has underperformed over the past decade too.

[Gary J is Rich on AMZN]

"The fund has performed reasonably well over the last 5 years compared to other dividend funds and the S&P 500, offering investors solid income and total returns."

This is what matters not "current". Market timing is for trading stocks not ETFs.

[Skeptical12]

@Gary J is Rich on AMZN This is a long-term call, not an attempt to time the market perfectly.

[Gary J is Rich on AMZN]

@Skeptical12

Then fix all of the "currents" in the article.

[Skeptical12]

@Gary J is Rich on AMZN I think this is the right long-term call right now. In the current market environment.

[GabsterX]

So now is the time to buy ETFs with more exposures to energy and commodities at all time highs?

[Skeptical12]

@GabsterX Many funds are at or near all-time highs, since the overall market is close to an all-time high, but investing is about the future, if people sold stocks or fund at their all-time highs 3 years ago they would have missed out on significant gains.