QQQ - MGK: Possibly Your Optimal Choice In A Growth ETF

2023-09-01 13:30:00 ET

Summary

• Vanguard Mega Cap Growth ETF is a focused fund with heavy exposure to 5 individual stocks and 3 sectors.
• MGK has a long track record and competitive expense ratio of 0.07%.
• In this article, I compare MGK to Vanguard Growth ETF and Invesco QQQ Trust, and suggest why it might be your optimal choice in a growth ETF.

(This article was co-produced with Hoya Capital Real Estate.)

For my review today, I decided to take my first ever look at Vanguard Mega Cap Growth ETF ( MGK ).

In this review, I am going to approach things from a slightly different perspective than I often do. In many cases, I try to look at how I think a particular ETF will fare in the current environment. As I did my research for this article-and in particular evaluating MGK against some competitive options-I decided to assume that an investor has an interest in growth ETFs and is more interested in helpful guidance in making a selection.

Having said that, just to make sure investors understand what they are getting when selecting an ETF such as MGK, here are a couple of snippets from the Principal Risks section of the fund's summary prospectus .

Large-cap growth stocks tend to go through cycles of doing better-or worse-than other segments of the stock market or the stock market in general. These periods have, in the past, lasted for as long as several years .

Due to a recent index rebalance and in order to closely track the composition of the Fund's target index, more than 25% of the Fund's total assets are invested in issuers representing more than 5% of the Fund's total assets. As a result, the Fund is nondiversified under the Investment Company Act of 1940, although it continues to hold more than 100 stocks across a number of sectors. The Fund's performance may be hurt disproportionately by the poor performance of relatively few stocks, or even a single stock, and the Fund's shares may experience significant fluctuations in value . (All italics mine, for emphasis)

As we take a look MGK's holdings a little later in the article, you will get a clear picture of what is being referenced in the above cautions.

Vanguard Mega Cap Growth ETF - Digging In

Vanguard Mega Cap Growth ETF seeks to track the Center for Research in Security Prices ("CRSP") Mega-Cap Growth Index . CRSP is an affiliate of the University of Chicago Booth School of Business. As implied by the name, only the very largest U.S. companies are considered for inclusion in the index, explained as follows.

The CRSP U.S. Mega Cap Index includes the largest U.S. companies, with a target of including the top 70 percent of investable market capitalization.

From that starting point, CRSP classifies growth stocks using the following metrics:

• Future long-term growth in earnings per share ((EPS))
• Future short-term growth in EPS
• 3-year historical growth in EPS
• 3-year historical growth in sales per share
• Current investment-to-assets ratio
• Return on assets

With an inception date of December 17, 2007, MGK has a long track record. It carries a very competitive .07% expense ratio, along with a minimal trading spread of .02%.

MGK is an extremely focused fund. You may recall from the summary prospectus that "more than 25% of the Fund's total assets are invested in issuers representing more than 5% of the Fund's total assets. As a result, the Fund is nondiversified under the Investment Company Act of 1940, although it continues to hold more than 100 stocks across a number of sectors."

Let's see how that plays out in a beautiful combo graphic that I have been using in so many of my reviews of late, from the Seeking Alpha webpage for MGK.

As you look closely at the graphic you might first notice that, for purposes of the statement I re-highlighted above, it appears that both Alphabet Inc Class A ( GOOGL ) and Alphabet Inc Class C ( GOOG ) are possibly being counted as one holding. Even if this is not the case, and only GOOGL is being considered, that statement is still very close to being the case at this precise point in time.

In addition to that heavy focus on 5 individual stocks, we can also quickly determine that roughly 80% of MGK is comprised of just 3 sectors; Technology, Consumer Cyclical, and Communication. In summary, in pursuit of growth, an investor is giving up quite a bit in terms of diversification.

Comparing MGK To Two Alternatives

As alluded to in the introduction of this article, in my research I focused on the question of how MGK might compare to a couple of different ETFs a growth-oriented investor might consider.

These two ETFs are Vanguard Growth ETF ( VUG ) and Invesco QQQ Trust ( QQQ ). As it happens, I have previously effectively reviewed both ETFs. My review of VUG can be found here . As an aside, in that review I did take the time to share my general concerns with the growth segment and that commentary would be even more acutely applicable to MGK as will be evident as this article continues. In the case of QQQ, my actual review is of its stablemate Invesco NASDAQ 100 ETF ( QQQM ), and I explain how the two ETFs are virtually identical. For purposes of this review, I used QQQ due to its longer track record.

To start with, here is an extremely high-level overview of some risk vs. return metrics for the 3 ETFs, courtesy of Hoya Capital Income Builder .

I might just focus your attention on one thing for now. As can be seen, in terms of number of holdings, MGK is far more concentrated than VUG and quite similar to QQQ.

Next let's begin a deeper dive into the similarities, and differences, of the 3 ETFs. Here's a look into the comparative sector differences, courtesy of a very helpful tool provided by Morningstar.

First, take a look at the comparison between MGK and VUG. What you basically see playing out here is what was hinted at above in the graphic from Hoya Capital Income Builder. The sector breakdown between these two ETFs is very similar, in fact there is an 86% overlap in the holdings of the two ETFs. However, with only 99 holdings as compared to roughly 240 holdings in VUG, MGK is even more focused on the heavily-weighted sectors I identified earlier. VUG essentially dilutes this slightly, with greater weightings in, for example, the Health Care and Industrials sectors.

Next, in comparing MGK with QQQ, we find an even heavier weighting in the Information Technology and Communication Services sectors in QQQ. In other words, QQQ takes MGK's focus to even greater extremes due to exclusively holding stocks traded on the Nasdaq index.

Another helpful tool in examining this is the Fund Overlap tool on etfrc.com.

I won't share that breakdown for MGK vs. VUG, due to that 86% overlap I mentioned earlier. However, in the case of MGK vs. QQQ, I believe it is worth doing as there is greater differentiation between the two funds. Have a look.

As we can see, as opposed to that 86% overlap between MGK and VUG, here the overlap is a much lower 60% by weight, and only roughly 45% in terms of differentiated holdings.

In the next section of the overlap tool, we get a closer look at the differentiation between specific holdings.

Here is what I want you to notice in this comparison. Looking in particular at the left side, you can see the slightly greater sector diversity of MGK coming into play. I won't list all the stocks because I don't want to have to specifically call out all those ticker symbols, but I'm sure you can see those related to health care, items for the home, and even chowing down on a Big Mac!

Lastly, let's take a look at a backtest of comparative performance. Happily, all 3 ETFs have an extremely long track record, allowing this backtest to extend all the way back to January, 2008. As I always do, all income is included and reinvested, so the results truly reflect total returns.

As can be seen, MGK carves out an interesting position in the overall risk/reward analysis. Basically, MGK has offered slightly higher returns that VUG over this 15-year stretch with virtually the same amount of volatility. That's always a good thing.

In terms of total performance, QQQ has easily outdistanced both competitors. However, it might be noted that a large measure of this came in 2021, followed by a deeper downturn, and then again this year, due to the frenzy surrounding AI. Given this, QQQ's greater volatility could either help you or hurt you at this point in time, depending on whether the AI hype ends up being overdone or not.

Summary and Conclusion

Investing in growth-oriented ETFs is not without risk. At the same time, for investors interested in including an allocation to growth in their portfolios, MGK might just be your optimal choice.

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