Torsten Asmus
Few investments remain appealing forever. With the market near record highs, valuations at elevated levels, and most indexes trading near the top end of their usual ranges, investing has become more difficult.
One fund that has been a top-performing ETF since the exchange-traded fund's launch is the Vanguard Information Technology ETF (NYSEARCA:VGT).
VGT is up 1,323% since the fund's inception in January 2004 using total returns, while the Nasdaq is up 2,132% during this same time frame using total returns.
Today, I am initiating coverage of the Vanguard Information Technology Index Fund with a rating of a sell. The ETF's holdings are heavily concentrated in just several companies, many leading big-cap tech companies also look overvalued using multiple metrics, and there are also signs that growth in the US and globally will continue to slow, the core holdings of this fund increasing headwinds.
The Vanguard Information Technology Index Fund has an expense ratio of .10%, a dividend of .63%, and the ETF currently has $87.56 billion in assets under management. The fund seeks to track the MSCI US Investable Market Index and Information Technology 25-50. This exchange-traded fund invests in large-cap tech stocks, the average market cap of the ETF's holdings is $746.6 billion. The three largest holdings of the fund, Microsoft (MSFT), Apple (AAPL), and NVIDIA (NVDA), comprise 48 percent of this Vanguard investment. No other holding makes up more than 4.6% of this ETF.
A list of VGT's core holdings (Seeking Alpha)
While VGT has performed reasonably well over the last two decades since the fund's inception, this technology ETF still consistently underperformed the broader NASDAQ index by a notable margin. The main reason this fund has done well over the last decade is the performance of the ETF's core three holdings, NVIDIA, Microsoft, and Apple. The Vanguard Information Technology Index Fund is a high-risk ETF because this investment has very minimal diversity. Apple, NVIDIA, and Microsoft only comprise nearly 25% of the NASDAQ, while these three companies make up nearly half the assets of VGT. The NASDAQ offers investors more diversity and less, and this index has still outperformed VGT over the last 20 years.
There are also a number of signs that a number of leading big-cap tech names are likely overvalued using a number of metrics. Microsoft is currently trading at nearly 38x expected forward earnings, while the company's 5-year valuation average is 31x predicted forward earnings. Apple is also trading at 35x expected forward earnings, while the company's 5-year average valuation is 27x predicted forward earnings. While NVIDIA is the only core big tech holding trading below the company's 5-year average valuation level, and most of the Vanguard fund's core holdings are trading at significant premiums to these averages as well. NVIDIA is trading at 49.53x predicted forward earnings, while the company's 5-year average valuation is 63x forecasted forward earnings.
There are also signs that the macroeconomy continues to slow, and the dollar is likely to continue to rise against most major currencies as well. Big-cap tech companies get nearly 60 percent of their earnings from outside of the US. First-quarter consumer spending levels were recently revised down and some analysts expect this trend to continue with higher interest rates making borrowing more difficult. Prices also remain high, the Fed is not likely to significantly lower rates this year.
Still, the US economy still remains the strongest in the world. Growth in the EU and Asia is also slowing, and corporate profits in the US remain healthy. The dollar is likely to continue the upward trend the currency has been on against most major currencies.
A Chart of the US Dollar (MarketWatch)
The Dollar has been rising consistently since January, when the currency reached a short-term bottom in late December of last year.
VGT will likely have some appeal to more aggressive investors focused on growth, but the fund does not offer investors balance. This ETF has very little diversity with nearly half the fund's assets in three holdings, and the fund has still underperformed the NASDAQ since the ETF's inception in early 2004. While tech companies have been some of the best-performing investments in the market so far this year, even investors looking to allocate capital to this sector should find other options more appealing.
