MCHP - I Don't Always Buy ETF - But When I Do I Prefer Vanguard

2023-03-05 05:10:12 ET

Summary

• While past performance may not continue, Mid-Caps have mostly outperformed over 20 years.
• And that includes any rolling 10-year period in the same time span.
• Mid-Caps may offer the salient points of both Large and Small-Caps.
• Vanguard is the best of breed when it comes to ETF.

I tend to pick my own stocks but do hold a couple of ETFs in Vanguard Real Estate ETF ( VNQ ) and Vanguard Utilities ETF ( VPU ) for differing reasons. I don't believe I've put in enough hours to fully understand the nuances in individual Real Estate holdings (commercial vs. residential vs. hospitals for example) and none of the utility stocks tower over the others, making it easier to hold the basket in both cases.

Being an individual stock picker, I did not pay much attention to Vanguard's Mid Cap ETF ( VO ) or its large and small cap siblings for that matter. But what I found about Mid-Caps caught my attention as explained below.

The Case for Mid-Caps

In specific, this article caught my attention when looking up the performance of Mid-Caps over time. Over the last two decades ending 12/31/2022, mid-caps have outperformed both large and small-caps 67% of any 10-year rolling period. During this 20 year period, we have been through

• the late stages of dotcom crash and ensuing recovery
• the financial crisis and recovery
• the most dovish Fed stance
• an aggressive Fed turning Hawkish
• the COVID crash and recovery
• and an almost equal number of years for Red and Blue policies in the White House

In other words, this is not a case of cherry picking over specific period of time nor economic policies. Even more impressive is that these returns came with lesser risk comparatively as stated in the article:

" Not only have mid-cap stocks generated higher absolute returns over a longer time frame, they have also provided these returns with less associated risk. Over the 20-year period ended 12/31/22, investors in mid-caps have experienced higher returns and lower risk relative to investors in small-caps. In addition, while mid-caps had more risk than large-caps, investors have been rewarded with a higher return over the same period."

But all that is past. What about the future? I expect Mid-Caps to continue performing well because I don't see a black or white scenario panning out over the next few years. The Fed and the economy are caught in a push-pull tussle where the policies cannot be too lax nor too aggressive. I don't see The Fed's 2% inflation target being achieved overnight. And that fits the Mid-Caps just fine as they are not small enough to be under constant macro pressure (think borrowing for example) and are still small enough to have sufficient growth prospects (the law of large numbers don't apply to much as much as they apply to the large-caps). In other words, they have:

• lesser volatility than small-caps
• less riskier than small-caps
• higher return potential than large-caps
• less exposure , meaning investors are likely under-allocated to this category

Why Vanguard Mid Cap ETF?

• When I am not able to pick best-of-breed individual stocks, I turn to the best of breed ETFs and there aren't many as venerable as Vanguard in that regard.
• VO has an expense ratio of 0.04%, which is miniscule but is typical of Vanguard when the industry average is about 0.50%. The difference may seem small if you look at them as percentages but when you convert them to every $1,000 invested, the difference is stark: 40 cents on Vanguard vs $5 being the average.
• While Vanguard is venerable, they are not out of touch with reality as evidenced by the sector allocation shown below. The fact that Technology and Financials are two of the top three holdings along with (slow growing and cyclical) industrials is a testament to their blended approach.
• Lastly, I like the holdings as well with the same blended approach showing up. For example, the venerable monthly divided payer from Real Estate, Realty Income Corp. ( O ) brings predictability while representing Semiconductors, Microchip Technology Inc. ( MCHP ) brings cyclical growth. Motorola Solutions Inc. ( MSI ) brings high dividend growth while Consolidated Edison, Inc. ( ED ) brings high yield. Well, you get the picture.

Conclusion

VO has so far outperformed its large cap counterpart Vanguard Large Cap ETF ( VV ) Year-to-Date but has underperformed the Vanguard Small Cap ETF ( VB ). As a sign of VO's short-to-medium term strength, it is now trading above almost all the commonly used moving averages as shown below. I expect VO to outperform the Small-Cap ETF as risk appetite is likely to slow down with The Fed lurking while the Large-Caps still need to adjust for its post COVID excesses.

To conclude, I always look for contrarian bets and mid-caps seem like they fit right in my alley in that regard. When it comes to ETFs though, in a nod to the most interesting man in the world , I don't always buy ETF but when I do, I prefer Vanguard.

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